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  • June 25, 2008 08:03 AM EDT by Elizabeth MacDonald

    Why the Fed is Likely to Sit Tight Today

    Expect the Fed to not cut or increase rates today, as it indicates that inflation is a bigger concern than recession. Though market watchers expected a hike in rates to stop inflation, a hike would be an extraordinary move in advance of the US presidential election.

    What this means is the economy will continue to muddle along for at least the next year or so, with flat to middling economic growth rates at best, as the Fed continues its agonizingly difficult task navigating the economy past the Scylla and Charybdis of inflation and recession.

    And what this means is many market watchers got it wrong.

    Did anyone in government give passing thought last August, after the Bear Stearns hedge funds blew up and the Fed opened the taps with a gusher of liquidity, that inflation would come bearing down like a freight train?

    Was there an unspoken plan back then between the administration and the Federal Reserve that the central bank would open the money taps here to save the financials, and in turn administration officials would then travel to the Mideast and jawbone Saudi Arabia to open its oil spigots, to help avoid US inflation?

    Instead, the US got promises of a tablespoon of increased daily oil productivity amounting to 9.7 mn barrels a day by July from 9mn currently, an amount that easily dissolves in a world that consumes 86 mn barrels of oil a day.

    And with the plunging dollar and the haymaker of inflation due to oil price spikes cutting into profits--half the jump in FedEx's operating costs recently was due to oil price increases--the self-appointed intelligentsia of the markets, the pundits who said a weak dollar would stop the economy from tipping over as it helps multinationals reap more overseas sales, don't look so prescient after all.

    Notably because oil price spikes are hurting economies struggling with rising inflation around the world, from Europe to Asia to the Middle East. These are the same countries that take the bulk of America's exports, a sweet spot in the US economy.

    And now, despite the most rapid Fed rate cuts in a generation, the financial sector must battle to continue to chop back its dodgy asset-backed securities propped up by all sorts of bad consumer loans, from mortgages to credit cards, securities Wall Street concocted that, on closer look, really are cut and paste jobs creating a drunken daisy chain of bad securities now sitting as landfill in investment portfolios extending to Australia, Asia, Europe, Scandinavian countries and the Arctic.

    Frankenstein securities backed by deadbeat loans increasingly defaulting right and left as borrowers bail en masse, dead loans walking. Unloading these illiquid assets in a downmarket is an Olympian task.

    Watch Wall Street's bum's rush out the door to the sovereign wealth funds, as the banks desperately seek to revivify their balance sheets. And watch whether the future holds yet another buyer parking its ambulance out in front of yet another Wall Street house to orchestrate another shotgun wedding.

    The Federal Reserve has clearly crossed the Rubicon, as economist Ed Yardeni points out, by opening its lending facility to investment banks, a window the Fed had said it would shut by September, though it's expected it will keep it ajar for any emergency.

    But watch this move. The Fed is now letting both commercial banks and investment banks swap all sorts of asset-backed bonds backed by dicey collateral for safer Treasurys, bonds that go beyond those propped up by deadbeat mortgages.

    The Fed is now taking on potentially more bad paper in the form of bonds backed by student loans, auto loans and credit card debt. The Federal Reserve banks now hold $549 bn in US treasury securities, down from $741 bn at the start of the year, Yardeni says. (Student loans have dried up, not good in a US presidential election year, as investors bolt from these asset-backed securities).

    With these moves, guess which bank the government is girding itself for as it might need a rescue, due to its vulnerability beyond mortgages. Citigroup (C)?

    And so back to the Fed's statement, due out around 2:15p, when the Fed-parsers, the market Gnostics searching for hidden meaning in Fed chairman Ben Bernanke's every intonation, come out in force. RBS Greenwich Capital, Merrill Lynch and Bank of America got it right.

    Watch as the Fed jumps up on a ledge to peer down, far from the muddling, madding crowd (yes, one of my favorite authors is Thomas Hardy, who said "character is fate," how true today).

    The Fed won't use language that says inflation risks now exceed the downside growth risks, which would indicate a possible rate hike soon, despite the fact that the Fed's inflation hawks have descended, with two Fed board of governor seats still vacant and the hawkish Fed presidents bringing the overall Fed under their wingspan of influence.

    Instead expect the Fed to use language that it is navigating that middle path, as it sits on the twin horns of a dilemma of higher inflation and recession, that it is balancing risks to both economic growth and inflation, as Merrill rightly points out. 

    Bank of America, too, says the Fed's "statement will acknowledge a still weak economy and elevated headline inflation, without tipping its hand as to the direction or timing" of its next policy move.

    And so the Tinkerbell of hope might be that the economic slowdown will reduce demand for oil and other commodities, bringing inflation down.

    The stock market and the economy will come back after the financials stabilize. Which they will after the writedowns end sometime after 2009. And when that happens, so will end the chapter of the "Great and Costly and Crazy Freelance Experiment by Wall Street to Bring 100% Homeownership to America."

    And so begins the next bubble: Energy (alternative sources of all stripes) and biotech.

    So all of the moves by the Fed and the government to repair the housing mess are laudable, noble and outrageously expensive, but the market in the end will fix itself.

    And we will still have to deal with the worst spending bubble of all. The chuckleheads in Congress and the administration who have no more sense than a flock of geese when it comes to using taxpayer money like their own private ATMs.

    And so we will have to continue to deal with a government that mindlessly foists on the backs of entrepreneurs, taxpayers and companies the largest budgets in history, as they build their Supersize-Me bureaucracy because they know better than you what's good for you and they know better than you how to use your tax dollars.

    That includes using tax dollars to bail out the housing mess.

    So inflation pays that tax bill.  

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DrZoidberg

Justin, I only live on this planet. Jupiter has always given off more heat than it absorbs. There is a neat formula in astro-physics that shows relation of mass to size, and Jupiter is pushing it. Some astro-physicists speculate Jupiter will implode and become a sun. Your argument seems to be the 'why' things are warming up. I'll argue petro is just bad to breath all day long, and diesel ? my god ? that's one of the worst things to breath. You seem to be a fan that things are warming up. So, why not just embrace the problem - if it helps ? this is how I distill the nutcases I run into that have to stand fundamentally unmovable on the blatent melting ice causing a rise in sea waters. Look at it this way, don't call it Global Warming, which no one disputes - call it The Melting Ice problem. Either way, you seem to be more involved here with 'why' it's happening. It is entirely possible fossil feuls + A rise in temps for all the planets puts the earth at extra-special risk. Even if it's not man made - it's a problem. Erosion for coastal properties has the insurance industry spooked, last I saw them on c-span. Maybe flood and rise of those 'A flood could happen to you' commercials are a way to bring up yet even more surplus funds for what's coming, who knows. Neither of us are competent probably Justin, to derive an 'absolute' correct answer on 'global warming' I just observe the trends and majority in thinking. I think at some point we have to rely on others intelligence. It's okay to not be right all the time, I'm wrong all the time. If fact ? I'm probably wrong about being wrong as often as I think I'm wrong. I lose in chess, but I win in that I learn how or why I lose. Loss is gain when coupled with a compassion to learn and understand life beyond our capacity to do so. I wasn't aware of solarsphere as a whole rising in temp, I'll certainly check that out for fun, but I do live on Earth, and I do know I'm subject to these climate changes. You can't tell me the ice melting isn't real in Greenland, and you know ? it's not coming back either - 1/2 is gone, just melted away - where'd it all go ? Into the water cycle, into the ocean, changes salinity, changes a lot of things. Maybe Groundhog day here would work, anything different is good ? perhaps not if it's 118 in the shade. Either way, we can prepare for these changes in a decent way - certainly - if the Bush admin 3 weeks ago - and I mean, they're never wrong or late, in their 3 year late climate report states petro fuels DO contribute to higher temperatures ? we should adhere to that right ? At some point, I really do think our children, or childrens children will look back and go 'Yeah, and they actually PAID for the oil too '. Oil is a dirty way to move cars around. Einstein said of nuclear energy 'That's one hell of a way to generate electricity' I think had he had time ? he'd probably join in on petro burning. I'm pro plastics, sure, but to go 'Lookey Leroy, it blows up real good, and just pours out of the earth, just don't wrap your lips around the exhaust it'll kill ya, or don't leave the garage door down, or don't pretend you don't live in a closed biosphere of the planet' is insane. 100 years is enough for oil. I'd re-examine lung cancer - really. I'd re-examine asthma - I'd re-examine health potential in general being denied. forget health care - if you can't even have clean air to breath ? Gee... I hope Exxon is sued by someone clever enough to take the bush climate report and say 'here, see ? right here, says petro exhaust contributes to rising temperatures' You and I BOTH know, petro exhaust is nothing you'd want to leave the baby carrier around eh ? yeah, all of a sudden put THAT way ? perhaps you see my point on petro. But my MAIN point on petro isn't that it causes warming, that's the bush admin saying that. MY main point is that it makes you sick- and unhealthy- and assaults childrens lungs - according to the AMA. You know, that American Medical Association ? oh yeah, I forgot, that organization is just 'a myth' eh Justin ? By the way - go pick up on some antiquity studies or real some Joseph Campbell - and discover a deeper more meaningful use of the word 'myth' while your at it, you mean falsity - the word 'myth' is mis-used MOST of the time. Then again I'm a fan of Ludwig Wittginstein, where he discerned 'The words meaning (in the end) IS it's use'. Either way Justin, clearing this up - the melting ice is real - you can play around with causal factors all day long, it's real though, and needs to be dealt with. NASA just came out (you know, those loser lying phonies who purport 'falsities' about earth and space ? how DARE they promote the earth isn't flat !) and demonstrated that the melting ice coupled with rising temperatures ? are contributing to very powerful storms- and that we can expect much more flooding as a NORM. I've no idea what rock you're living under Justin, you're pretty much - in a Simon and Garfunkle send - an island on this issue - what's to debate - the ice is melting, the floods are getting worse, the sea level IS rising, the temperatures ARE rising - and petro makes you sick AND of course, the bush admin finally concurs that petro burning contributes to rising temperatures - as the majority of earth scientists on the planet. All I hope YOU can see is that - regardless of WHY the temperature is rising - we need to deal with it, and all in all ? I happen to believe and rely on the MAJORITY of the world's leading scientists AND nation states who come forward stating that indeed - burning fossil fuels DO contribute to rising temperatures. For our dialog, you can leave that out and get back on the real melting ice, and how you think we should derive value out of coastal properties before they go under - (go under ? get it ?) I've not idea why you want to play devils advocate on this Justin. It's the ann coulter in ya !

June 26, 2008 at 2:16 pm

DrZoidberg

Good job Ben Bernanke ! shoulda gone 0.25 % I bet you will on Friday or Monday ! a falling dollar makes everything else USELESS. And Paulson and bush have the gaul to come out 'We're FOR a strong dollar' yet - as this article says - they just SIT there Sure - trying to influence the markets by adjusting rates is like the delay in the mars lander from the time instructions are sent - to the time it moves. BUT- 0.25 up would have said "we're reaching for a stronger dollar" futures would have started to recede back to sanity - people going long might panic - knowing, uh oh, dollar is coming back but - even IF it goes up 0.25 % at this point Fed has to now watch what ECB does. How is it ECB cares more about a strong euro than the US Fed cares about a strong US Dollar ? Dow down negative 350+ today Futures on oil is killing everyone - even the airlines - and Bernanke just SITS there - watching the dollar slide - gee. What IS the responsibility of the Fed again ? one of the TWO responsibilities ? I'd say it might be time to forcibly oust Bernanke and bring someone in who isn't afraid to shave off their beard at risk of thinking their character goes with it.

June 26, 2008 at 4:13 pm

DrZoidberg

Although this insight isn't germane to this article, I thought - hey I'd post it anyway. My thoughts on oil hitting 140 today are close to how I look at gold. That gold moved SO much today ? I say - that's not gold going up - that's the dollar worth LESS requiring MORE USD to buy the same amount of gold. Same with oil. People are reading oil futures ALLLLLLL wrong. It's not that oil is going up because of demand - Oil 'appears' to be going up because the dollar is becoming worth LESS hopefully not worthless - heh but - that's all- that's how I see it. That's also why I think 0.25 + yesterday would have been a baby step in the right direction. Even a 0.125 perhaps - I mean, why not send out that message that the Fed is on it's job watch of protecting against inflation. Instead ? We now have a stock market that lets oil influence it, and people start thinking 'oh wow, oil is going up, I better buy it now, then I'll sell when it's even higher' yayhoos - all of em all they're REALLY investing in is a belief the dollar will be worth less. It's frustrating to watch - that people actually think they can win shorting the dollar even. What a useless life if you ask me - to short the dollar. That's not what makes world class economies - shorting the currency - what makes world class economies are world class societies that have civil law and civil rights protected, where workers MEAN something more than something that can be chopped off by the thousands (of workers) to make for a better bottom line come quarterly reports. Can ANYONE really SANELY say ? they're MAKING money ? shorting the dollar ? think about it. Oh well - that's all I wanted to convey is - oil and gold aren't going up. They are an index that the dollar is falling. You can also watch the dollar fall in relation to other currencies too I suppose. But it's dangerous to think oil is actually 'going up'. At some point, the dollar will fall to the point, it will become clear that - well- the higher oil gets the less the dollar is worth, at some point, you'll have hyper-inflated oil - where every other part of your lifestyle will be pegged to THAT - including food. At THAT point, people will start jumping the fence to get INTO Mexico.

June 26, 2008 at 4:46 pm

DrZoidberg

Maybe just keeping rates steady IS the equiv. of raising them 0.25/0.50 considering the trend has been to lower them ?

June 26, 2008 at 9:41 pm

TJ

Why can an high school graduate in the Army realize that this was going to happen. Because they lie to us. The Fed new they were going to be in this position. You know how I knew. I LISTENED TO DR. RON PAUL. He has been saying this for 30 years.

June 26, 2008 at 10:09 pm

about this blog

  • Elizabeth MacDonald is the stocks editor for Fox Business Network. She is recognized as one of the top prize-winning business journalists in the country, and has received 14 awards, including the top prize in business journalism, the Gerald Loeb Award for Distinguished Business Journalism, and the Newswomen's Club of New York Front Page Award for Excellence in Investigative Journalism.

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