Playing
Chicken With the Fed
By Duru
April 17,
2005
How low can we
go? My man, Mike, has an
excellent summary of just how ugly things have gotten in the markets
now. I am particularly surprised that
the S&P 500 did not survive the test of its 200DMA. In "typical" panic sell-offs, the
S&P has been the last to hit this oh-so-important long-term support for
bullishness…and when that test succeeds with buying interest, it pulls the rest
of the market back up with hope and good cheer.
I have also been claiming that we should get about two weeks of rally
out of this earnings season. The bulk of
earnings season is happening in the next two weeks, so if my theory is to hold any
water, the previous two weeks of pessimism must give way to a pretty vigorous
rally starting this week. I will
re-emphasize Mike's point though…catch all the falling knives you want, but
this market is stinking up the joint really bad…the bias is to the
downside…big-time. The bear is growling
loud and strong.
Mike has said
that it feels like the market fears something big is about to hit us. This kind of selling tells me that the market
fears recession. However, the Fed has
said nothing about economic weakness. In
fact, they are preparing to cool down what they see as a looming threat of an
economy getting a little bit ahead of itself.
I find it extremely ironic that the market actually rallied when the Fed
bared its teeth and drew its sword during the latest round of Fed-mania. The short-lived optimism that came from misinterpreting the Fed minutes
has no doubt made the current selling even worse. There are still a lot of folks who agree with
the Fed that the economy is just fine, and the longer they continue to buy for
bottoms, the longer we wait for a real bottom.
The market is
in a mode of playing chicken with the Fed.
It is essentially screaming out for the Fed to cease and desist from its
campaign to stomp out inflation. The Fed
will have an extremely hard time talking about economic strength and inflation
while the market deflates before its very eyes.
The market does not know how far down it must go, or how much pain it
must inflict, to get the Fed to back down, but it is going to do its best. The worst thing about the box the Fed has
created for itself is that all this market weakness is driving long-term
interest rates down again. Investors and
traders are fleeing for the relative safety of Treasuries as they anticipate
future economic weakness. The Fed wants higher
rates to fight inflation and squash speculative frenzy. With this in mind, the housing sector must be
the specific target because there is almost nothing else working well in the
current economy. But now these
stubbornly low rates will only further support the lofty levels of the housing
market (I am being economically correct in avoiding the term
"bubble"!). If the Fed backs
down from its current campaign, they will leave an economy disturbingly
teetering on its own over-sized leverage.
They will signal to the consumers that spending remains better than
saving, speculating on housing remains better than investing, and corporations
will become even more uncertain given the apparent capricious nature of the
Fed. The Fed seemingly has no choice but
to press on with rate hikes. Perhaps
they can clearly communicate some sort of cap, but they will loathe binding
themselves even more. If poor Greenspan
was befuddled by the persistence of low long-term interest rates, he is
probably going to break out into a cold sweat now! (This
is what he said to the Committee on Banking, Housing, and Urban Affairs, U.S.
Senate on February 16, 2005: "The favorable inflation performance
across a broad range of countries resulting from enlarged global goods,
services and financial capacity has doubtless contributed to expectations of
lower inflation in the years ahead and lower inflation risk premiums. But none
of this is new and hence it is difficult to attribute the long-term interest
rate declines of the last nine months to glacially increasing globalization.
For the moment, the broadly unanticipated behavior of world bond markets
remains a conundrum. Bond price movements may be a short-term aberration, but
it will be some time before we are able to better judge the forces underlying
recent experience.")
None of this
weakness should come as a surprise to us.
We
began the year with these very same fears of a suddenly unfriendly Fed. The market sold off the new year with force
once it got its first taste of the "new" Fed. But the Fed also made plenty of deflationary
comments back then to send the market into manic mode for 2005. We watched in horror as the market careened
quickly wiping out all the green from 2004 and then some over the first 3 weeks
or so of the year. We watched in glee as relief from earnings bounced
the market to challenge 52-week highs.
And now we watch in renewed horror as the market has spent the last 6
weeks or so grinding its way down to new lows for the year. We have even given back ALL of the
post-election cheer that sent the indices hurtling upward. Can the 2004 lows be all that far
behind? One thing seems clear, the decade-long
trading range that I have spoken about is still in full-effect. Buying when all seems well is still a
money-losing proposition. By my count, I
still have another five years of warning you to…be careful out there!