Asia reverses and the Fed's on deck

Asia bourses across the board were down 1-3% percent, but they reversed and closed up an average of 3% off their lows. And now the market is "waiting" for what the Fed governors had to say about the economy in their latest FOMC minutes.

The Fed is trying to play chicken with the market. They did it in August and blinked. They'll do it again. The market knows it, and so do the currency players, and so does the bond market, as they've pushed the two year down to 3.17% percent, and even the 30 year is yielding less than the Fed funds rate. Meanwhile the jokers on the Fed are worried about inflation, while house prices are in a deflationary death spiral. Tight money won't affect the price of oil. If the Fed wanted oil prices down, they should jawbone the CME to raise margin requirements, instead of keeping short rates at a level that is toxic to the economy.

A normal yield curve would indicate that the Fed funds rate should be around 3%, so all the bluster by the Fed is just nonsense and it is recognized by the market as just that. Nonsense.

So let's look at those who run bonds and didn't get involved with sub-prime. Here's what Paul McCulley of PIMCO, the largest bond house in the world, had to say in his December Global Central Bank Focus:

Essentially, my thesis is that overnight money, carrying zero price risk, zero credit risk and zero liquidity risk should not yield a real, after-tax return. A 50-basis-point real rate in the context of a 2% inflation rate – my definition of ‘effective price stability’ – would translate to a zero real rate on money: a 2 ½% nominal rate, with 50 basis points going to Uncle Sam for taxes (assuming an average marginal tax rate of about 20% in this country) and 200 basis points making the holder of money whole for inflation....

......In retrospect, the Fed did not give a hoot about my estimate of the “neutral” short rate, driving the nominal Fed funds rate to 5 ¼%, which translated to about 3% in real terms (before taxes), depending upon your preferred inflation measure...

....Which brings us to the here and now: we are living in a debt-deflation fat tail, also known as a Minsky Moment....The shadow banking system is being turned into a shrunken shadow of itself, as my partner Bill Gross articulately explained just a few weeks ago in his monthly essay, “Shadow Dancing” Most important, from an investment perspective, a Reverse Minsky Journey will have the precise opposite, probably more violent, effect on the ‘neutral’ real Fed funds as the Forward Minsky Journey of 2004–2006. A Reverse Minsky Journey will lower it dramatically, as the implosion of the double bubbles of housing prices and the shadow banking system renders the demand for credit very interest rate inelastic to Fed easing...

...What I do know, or at least think I know, is that the slower the Fed is in lowering the Fed funds rate, the greater will be the cumulative decline in the Fed funds rate. Debt deflation is a nasty beast and will not be tamed with a gentle monetary policy response...

And that, like it or not, is what is happening in credit land. Get used to it. The credit markets are in turmoil because the Fed cut 25 basis points on Halloween instead of 50. They weren't aggressive enough in addressing the problems in the shadow area of banking. Leveraged loans, derivatives, and asset backed paper need a much lower Fed funds to function properly.

Since the Fed didn't lower the rates, the market is doing it for them. Bonds and the dollar are reflecting that the Fed funds rate will be materially lower in the future.

But stocks are not. Stock buyers apparently believe the Fed's rhetoric, whereas bonds and currency players have already dismissed it.

So buy the trade that is cheap. Buy stocks now. They're ringing the bell at the bottom.

DJIA 12958.44
S&P 500 1433.27
Nasdaq Comp. 2593.38