The public equity and debt markets in the US acted like the Fed was truly the “Grinch That Stole Christmas” immediately after the Board announced a decision to cut the Federal funds and discount rates by merely a quarter point rather than half point many market participants had argued for in the case of each rate, and even both. The Fed pronounced a judgment of ”uncertainly” about the future direction of both economic growth and inflation, while these market players clearly believed that the risks of a recession should far outweigh the risks of inflation in the Fed’s determinations.
One could feel perhaps enough sympathy for the Fed Board as it seems locked in a battle of wits and wills with a market that thinks they do not know what they are doing. One could almost conclude, then, that the Fed’s move the next morning announcing a new auction mechanism to inject $40 billion into the international credit markets was not a “flinch” in the face of market uproar but rather a kind of “sucker-punch” to the equity and debt market players who had so quickly bet against the Fed’s judgment. (That’ll teach ‘em not to flock to Treasuries!)
The truth may lie someplace else, however; Thursday’s and Friday’s seriously elevated PPI and CPI data introduced a novel proposition to the markets — maybe the Fed is right! Maybe there is more uncertainty than any other phenomenon just right now. Maybe the Fed was correct in holding a bit of its firepower and engaging in a more surgical attack on the illiquid conditions in the global credit markets — especially the excruciatingly high LIBOR inter-bank rate, a benchmark for a wide range of routine credit financing.
Thus far, LIBOR has not really responded, but that will be an interesting number to watch next week to see the Fed’s auctions will indeed make a difference. Ironically, it could be that a renewal of confidence in the Fed’s judgment may now be a prerequisite for the classic “December rally”that equity market participants are pining for (when they are not swooning to get the Fed’s attention).
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