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A good Snooker player is a sign of misspent youth. One tactic commonly used is to block your opponent’s ability to make a clear shot, otherwise known as the snooker. The Free Urban Dictionary defines snookered as - To lead (another) into a situation in which all possible choices are undesirable; trap.

Hey, sounds like the position the Fed is in.

Let’s recap:

Housing stocks have taken a decidedly bearish tinge as it looks like the next down leg is underway:

Chart 1 - Centex (weekly) broken support

CTX

Centex has recently moved below its July ’06 lows ushering in the next down leg in housing stocks (Fibonacci target – $30). Below is the 10-yr bond price. Housing stocks and bonds are very closely correlated.

[The housing stocks preceded weakness in the real estate industry by about 6-months. If the above chart is anything to go by, late Fall and Winter are going to be panic months in housing.]

Due to its enormous size, a bursting Real Estate bubble has the potential to sink the economy. The Fed cannot allow this, so what are they to do?

The obvious – cut interest rates and give away free money.

But there is one major problem. Lower short-term interest rates will play havoc with an already weak US Dollar:

Chart 2 – US$ trending lower (blue lines); bottom 10-yr treasuries 2 month time lag.

usd

The USD (top chart) has been in a downtrend for much of the 1st quarter 2007. During this time short-term rates (not shown) have topped out which implies the Dollar has been discounting future Fed rate cuts. In fact the Dollar has been making lower tops for over a year (not shown).

Here’s the Snooker:

There is an interesting correlation between the Dollar and Bonds. By offsetting the 10-yr Treasury Note against the US Dollar by 2 months, the inter-market picture becomes apparent.

• The Dollar topped out in mid-October 2006 and fell until the beginning of December - Bonds topped out 1.5 months later and fell until late January.

• The Dollar bottomed in December and rallied until late January - Bonds rallied for much of February and into early March.

• The Dollar has been weak since February and the above chart suggests Bond weakness may follow for at least the next 2 months (maybe more if the Dollar weakens further).

So cutting rates may not be much of an option. It will weaken the Dollar and cause long-term rates to rise (Bonds to fall) which will knock on an already collapsing housing market.

In the absence of sufficient ammo, the Fed will continue to talk tough for as long as possible, trying to convince the market that the economy is strong. But the economy is not strong, manufacturing and services are slowing whilst Oil and Food prices are rising.

Whilst the Fed talks empty words, inflation fears are increasing. When the Fed is finally forced to cut rates to prevent an all out housing collapse, Gold will soar as a combination of massive monetary creation collides with mounting price inflation.

Gold is the steal of the century at these levels!