Spencer Jakab
The Fed is butchering its currency
Dow Jones
The year-old financial crisis is acting like a monster from a bad horror movie, briefly reeling from whatever blows are thrown at it and then coming back scarier and angrier to claim more victims.
The latest victim seems to be the hedge fund Carlyle Capital, which is seeing its assets seized just two days after the boldest move yet by the Federal Reserve Bank to stem the financial panic. Global equity markets plunged at the open, whittling away much of their gains from Tuesday's effort to halt what analysts at JPMorgan dubbed a "systemic margin call".
With futures markets now pricing in a 94 per cent probability that overnight rates will drop to 2.25 per cent in five days' time, down three full percentage points since September, the Fed is like the terrified character in the movie who first tried a two-by four, then an axe, a gun and finally a bazooka, all in vain. It seems the only hope is to stun the creature long enough to regain our nerve, since fear is a big part of the problem.
Economist Paul Krugman wrote in a New York Times op-ed Monday that the tools at the Fed's disposal are puny compared with the multi-trillion dollar scope of the problem, and that a "slap-in-the-face effect" might "give hysterical markets a chance to regain their sense of perspective". Federal Reserve Chairman Ben Bernanke and company certainly gave it their best try, but the 416 point bounce in the Dow and brief fillip to credit markets barely lasted 24 hours. The belief back in August during its initial discount rate cut that it could save the day has turned into a fear that it is powerless to bail out reeling financial institutions.
"The market was beginning to believe that the Fed was impotent even before this," said Peter Boockvar, equity market strategist at Miller Tabak. "It doesn't matter where interest rates go if people won't lend money."
Not everyone in the market has thrown in the towel. Seeing the glass half full, some view the Fed's willingness to take such bold action as a positive sign for equities, though perhaps not for the greenback.
"My perception is that a lot of this is because the Fed has been behind the curve, is willing to get in front of it and is willing to do what it will take to calm markets and improve liquidity," said Robert Stimpson, an equity portfolio manager at Oak Associates. "While the rally was short-term, it's more about the willingness of the Fed, and that's a good sign."
But the financial markets encompass much more than equities and fixed income. The very hope that the Fed's aggressive move gave to equity investors like Stimpson is striking fear into the holders of dollars around the world, pushing the Japanese yen below 100 to the dollar for the first time in almost 13 years, and sending gold futures above $1,000 an ounce for the first time ever. The notion that the Fed is keeping all options open has sapped confidence in the integrity of the world's major reserve currency as visions of the turbulent 1970s or, even worse, the 1930s, come to mind.
"The dollar index is just in freefall, down 13 out of 16 days," said Boockvar "The Fed's just printing money – they're like a butcher slicing the Fed funds rate."
Stimpson agreed that inflation is a real concern, with so many commodities breaking records, but he said he doubts there will be a dollar crisis. As for equities, he sees the 1270 level on the Standard & Poor's 500 as an important psychological support level as it approximates both the 200-day moving average and the intraday low in January. A break below that level could create scope for more downside, and a defence of it may signal the worst is over for stocks.
For Boockvar though, 1150 is a more realistic target, and he insisted the Fed's moves are prolonging the pain. With the most exposed financial institutions such as Bear Stearns and Countrywide Financial down sharply Thursday, at or near their 52 week lows, the belief that there are more blowups ahead is trumping faith in the Fed for the time being. Boockvar said that irrational prices caused by the panic may make sense. Some market observers have pointed to the fact that assets holding the implicit backing of the US government, like the bonds of Fannie Mae and Freddie Mac, are now under siege.
In a "mark-to-market world" there is an opportunity cost to holding even these safe investments if they can fall even more in the near-term. The fact that they have fallen victim is just the latest symptom of the nasty credit crisis.
"It's just a disease that started a year ago that continues to spread," he said. "It's just spreading to areas we didn't think it would."
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