Wednesday, October 31, 2007

Are the Markets FED Up?

The FOMC of the Federal Reserve Board reduced, as expected, the federal funds rate by 25 basis points, or 0.25% to 4.50%. This was the second consecutive reduction in the federal funds rate, following September's 50 basis point cut.

The markets responded with common bravado, with the major indices up sharply. In the statement released today, the Fed stated that following this reduction, the inflation risks roughly parallel that of economic deterioration, meaning that they may pause when they next meet on December 11.

Read the full Fed statement.

Dow 13,930.01 +137.54; NASDAQ 2,859.12 +42.41; S&P 500 1,549.38 +18.36; NYSE Composite 10,311.61 +146.64

Essentially, the Fed knows they cannot lower rates without regard to the intense pricing pressure from commodities, especially oil, because doing so would risk the erosion of the dollar even further. This puts Bernanke and the Fed in quite the prickly position. Wall Street and the Republicans want softer rates and a solid economy, while economists everywhere are telling them that the US dollar cannot take any more of a beating. Somewhere in the middle is the US population, seemingly stuck between a stagnant economy and higher prices for everything - stagflation.

What stood out in today's trading was the action of the economically-sensitive banking sector and the overall muted reaction to the smallest cut the Fed could make. The Dow, just prior to the release, was already up about 90 points on news that 3rd quarter GDP checked in at a solid 3.9%, so it only added 40 points on the rate news.

Stocks such as Countrywide Financial (CFC), Citigroup (C), Merrill-Lynch (MER) and Bank of America (BAC), actually lost ground following the release. All but Countrywide - which dropped a full point after the release - regained all or most of the ground given up, mostly due to short-covering rallies. The banking sector is in crisis mode and many investors are acutely aware of the condition of credit markets.

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Breadth was actually solid, with advancing issues leading decliners by a 22-9 margin. New highs outpaced new lows, 420-233.

As if to magnify the folly of the Fed's latest move, oil for December delivery advanced by a huge number, up $4.15 to close at $94.53. Gold closed sharply higher - up $8.20 to $796.00 - as did silver, gaining 13 cents to $14.46.

The commodity markets responded even more bluntly than the equity markets to Bernanke's boneheaded maneuvers over the past two FOMC meetings. One has to question both the validity of government data and the wisdom of the Fed as currently composed. On Friday, October Non-Farm Payroll data is announced prior to the open and that data will shed more light on the economy.

Let's all join hands and pray that the Fed did the right thing at the right time.... On the other hand, let's all go out and have a couple of drinks. We're going to need something to stiffen our resolve for what's ahead for the US economy - and it isn't a pretty picture.

Short bank and financial stocks. Bank failures are a sorry possibility and more severe economic disruptions will occur in 2008.

NYSE Volume 3,957,900,250
NASDAQ Volume 2,593,399,750

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