Bernanke's market honeymoon is
over By Julian Delasantellis
You hear them all the time next door. The
loud, angry and obscene language. The sound of
flying plates, pots and pans striking the cabinets
and the floor. Doors slamming. Somebody getting in
the car and speeding off. You know what that means
- it’s the unmistakable sound of those volatile
neighbors bickering again.
Tuesday saw
another 300-point decline in the US Dow Jones
Industrial Average. You know what that means. It’s
the US
Federal Reserve and the US
financial markets bickering again.
For the
fourth time since August 17, the US Federal
Reserve Board has sliced short-term interest
rates, part of the continuing effort to counter
the negative economic effects of the subprime
mortgage crisis. Tuesday’s move involved twin 25
basis point cuts in both the Federal Funds Target
Rate, to 4.25%, and the Federal Funds Discount
Rate, to 4.75%.
Yes, it seems like the
honeymoon sure is over for the Fed and the
markets. The markets were thrilled with the first
easing move in this cycle, the 50-point cut in the
discount rate on August 17. That sparked a
230-point rise in the Dow for that day, a
550-point rise for the following month. The
surprise twin 50-point cuts in both the target and
discount rates on September 18 were even more
appreciated, driving the markets to all-time highs
over 14,000 in early October.
The markets
and the Fed were getting along swimmingly around
then. The relationship was very clear and well
defined; the markets, as interpreted by the
implied cut probabilities of the Chicago Board of
Trade’s Federal Funds futures contract, asked for
cuts in interest rates, and the Fed gave them. The
equity markets rose, Federal Reserve chairman
Bernanke started to receive a bit of the economic
savant accolade that former chairman Alan
Greenspan had so long reveled in, and everybody
seemed happy.
Then, as so frequently
happens, one partner in the relationship changed.
The Fed, as people used to say in the pre-feminist
era, decided that it wanted to wear the pants in
the family. In the days prior to the next Fed
meeting on October 31, the Financial Times
reported that some Fed board members were chafing
under the apron strings of the financial markets
that they wanted to be able to decide on the
appropriate levels of short-term interest rates
independent of the market’s dictates. (See my
November 2 Asia Times Online article, Bernanke: Don't take me for granted,
boys.')
The Fed did deliver
another dual interest rate cut on October 31, but
by then the markets were not looking at what the
Fed was giving it but what it said it was going to
give in the future. The markets read the statement
that followed the meeting, and interpreted it to
mean that they could expect few, if any, more
interest rate cuts in the immediate future.
The markets also didn’t like Bernanke’s
speech to the Cato Institute in Washington on
November 14, in which he elaborated on a new
framework for deciding whether to cut interest
rates that seemed to severely limit the role of
the markets in Fed decisionmaking. (See my
November 17 article, Playing 'chicken' with the
markets.) That, along with various
early November statements from Fed officials
proclaiming that, at least for now, the rate cuts
were over, meant that the Fed had lots of
explaining to do to the markets when it came home
in mid-November.
''I’ll show him who’s
boss,'' the markets fumed. From November 1 through
26, the Dow Jones Industrial Average lost 1,300
points, about 9% of its value; it was the worst
month in the markets since 2002. By late November,
the Fed was once again cooing and wooing the
markets with the very sweet romantic affirmations
that it knew they loved to hear - that it was
willing to start the interest rate easing cycle
once again. From late November to this Monday the
Dow threw in an impressive, 1,100 point, 8.6%
rally, to 13,800.
But, as Tuesday’s
selloff proved, the markets wanted something more
than what they found when the wrapping was removed
from the Fed’s latest present. Evidently, they had
wanted twin 50-point cuts, or at least a 25-point
cut in the Federal Funds Target rate along with a
50-point cut in the discount rate. There was also
probably not a lot of appreciation for the line in
the Fed’s post-meeting statement that ''elevated
energy and commodity prices, among other factors,
may put upward pressure on inflation. In this
context, the Committee judges that some inflation
risks remain, and it will continue to monitor
inflation developments carefully.''
In
other words, I hope you like your present, Mrs Dow
Jones. Don’t expect much more anytime soon.
The next move is up to the markets. If the
selloff continues and accelerates back to the
mid-August/late November lows in the mid 12,000s
or lower, then the Fed will certainly cut again,
maybe even before its next regularly scheduled
meeting on January 31. However, if the selloff
does not continue, or if the rally resumes, then
Bernanke’s big gamble may just pay off. He may be
able to accomplish something Alan Greenspan never
could - that is, retake the policy initiative
(grab back the pants) from the markets.
Whatever happens next, the Tuesday selloff
proves just how fragile and illusory the surface
normalcy that seems to have returned to the
markets really is. Before the selloff, the Dow was
only 470 points, one really good day, from the
all-time highs of early October. Now, it seems
that the entire market rebound from the summer
panic lows was built on the presupposition that
the Fed would cut, cut and cut again, with the
speed, and in the quantity, that the market
desires, and not one basis point less.
Tonight, I know I will sleep fitfully. I
will awaken repeatedly through the night, rolling
over and checking Bloomberg TV to see whether the
Wall Street selloff has spread to the Asian and
European equity markets. For those of us in the
financial markets neighborhood, the fighting
between the Fed and the markets actually is
keeping us up all night.
Julian
Delasantellis is a management consultant,
private investor and educator in international
business in the US state of Washington. He can be
reached at juliandelasantellis@yahoo.com.
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