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Wednesday, December 12, 2007

Market and the Fed throw "hissy" fits

Yesterday the Fed blew it. So they wanted a do-over, and they hastily announced their liquidity plan. The ECB, Bank of England, Bank of Canada, Swiss National Bank and the Fed will coordinate lending money to the banks, collateralized by what the banks would have brought to the discount window. Why did they do it this way?

That's what the market was ticked off about. Stock investors want simple answers. The rate that the money will be lent by the Central Banks is the average of the Fed funds rate for the time the loan is out. Let's break this down to simple numbers. The Fed funds rate is at 4.25% and the discount rate is at 4.75%. Using the method that the Fed proposes, banks will be able to borrow at 4.25%, 50 basis points less than the discount rate. So why didn't the Fed just cut the discount rate 75 basis points yesterday, to make it and the Fed funds at the same rate? Then there wouldn't be a "stigma" to borrow from the window because there would be no penalty rate.

Now look at traders positions. Yesterday the bet was the 25 basis point cut wasn't enough. So short the market, and oil and go long bonds. The market gapped up almost 300 points, oil gapped up and ran $4 dollars, and bonds got cratered. The overnight traders got crushed.

And the Fed just looked stupid. They leaked this news last night to Steve Liesman of CNBC. They'll give you some poppycock reason, about releasing it when all markets are open, but the Fed had no intention of releasing this news today, until the market got crushed. They only stated they wanted to make the announcement when the affected market's were open. A factually true but misleading statement. So the timing stank. The Fed, who only wants to move during FOMC meetings, moves immediately after the meeting?

But it will provide some liquidity to the market place. If they cut the discount rate to 4.25%, they would of been overwhelmed. So meter out $40 billion here, $5 billion here, and pretend you're doing things surgically. That will satisfy the academics of the Fed, and be the cover for Bernanke's "exceptionally alert and flexible" statement. But the money is a start. And when the market was down 90, it looked like the bears had over pressed their bets, while the working group on markets stepped in and bought stocks up to the close.

Tomorrow we have Lehman's earnings and inflation figures,and somehow I think they'll both go hand in hand.

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