Fed is Punishing Dollar Holders

I received an interesting Email tonight from a friend about punishing dollar holders. Here goes, from Conor:

I sat at my desk 30 minutes before the FOMC release wondering what the Fed would do. And then they cut 50bps. So that's how it's going to be, eh Ben?

What followed was what you'd expect. Stocks were up strongly, with the S&P up 2.9%, homebuilders up 6%, bank and brokerage stocks up huge, gold up $15 to a new 27-year high, gold equities up 4%, crude up again to close over $82, and the dollar weaker, finishing at a new 15-year low. I don't suspect that today will get a chapter in the eventual tome on the fall of the dollar, but it certainly merits a footnote.

When gold and crude are making near-record highs and the dollar is making near-record lows, I think prudence dictates rate hikes, not rate cuts -- as Marc Faber and Jim Rogers pointed out today -- but cutting rates 50bps instead strikes me as insanity. Nonetheless, these are the cards we have been dealt, and now we must bet accordingly.

The conclusion is obvious: the Fed is telling us that it will punish dollar holders. And like the oldest adage in the book goes, "Don't fight the Fed." By holding dollars in cash/savings, you will be earning less and less on your money, and be losing as the dollar declines in value relative to other currencies, paper assets, and commodities.

Was this a "one and done" cut? Hardly. GDP growth is likely to remain sluggish for several quarters, dragged down by housing and probably employment as well. These excesses don't go away with a snap of the fingers and a 50bps rate cut. That's what's so perplexing -- odds are the economic data will be no better, and probably at least a bit worse when the Fed meets at the end of October. They're going to have to cut again. And where will already-trending gold, oil, and the dollar go with more rate cuts?

The bottom line is the Fed's mandate has shifted from price stability and filling the needs of business to full employment and low inflation to its current form, which is preventing asset deflation/credit contraction and recessions. If we think we can use the Fed to foster booms and at the same time prevent the after-effects of those booms we are sadly mistaken.

Thanks Conor. You are correct. The Fed is indeed Hell Bent On Punishing Dollar Holders. That is the plan. I have been telling people for months that the Fed does not give a hoot about the dollar.

The top three Fed concerns are as follows:

• Bailing out their banking buddies
• Bailing out their banking buddies
• Bailing out their banking buddies

Stops Cleared
Was the rate cut move was telegraphed in advance?

I am actually surprised given all the PPT theories floating about that no one has commented on this. But I have been watching FOMC announcements every meeting for years. A general rule of thumb is that the first move on the announcement is the fake move. Not always but usually. But in years of watching, this is the first meeting I have ever seen the fake move begin before the announcement.

Because of the magnitude of the reaction, the scale masks the preceding move. But anyone trading or watching futures has to know what I am talking about. Roughly 30 seconds to 1 minute before the announcement, the fake move came. At the time I actually thought the announcement came and Bloomberg was late in reporting it. But a sudden spike in price and volume 30 seconds before the announcement is just not normal.

Was there a leak and stops run in the opposite direction?

Perhaps many are thinking that I am complaining because I was short. That's not the case. I was long gold headed into this announcement and I was short nothing. In addition, I am in a mortgage that will benefit from this rate cut immediately even though I was not in favor of it. Thus I benefited twice from this cut with no negative consequences.

To the numerous people who have been Emailing me recently telling me to "Please give Bernanke the benefit of the doubt". What say ye now?

My call was that Bernanke would make a 50 basis point cut on the basis of the recent jobs report. (For more about jobs, please see Moonbats Active Again in Massive Jobs Disaster). But no, I did not say go long. So as far as my FOMC calls go, it was a mixed bag.

And even though I was on the sidelines, I have to say I was surprised by the strength of this move. But here we are in yet another options expiration week and I am quite confident the Fed was aware of it. They pulled a surprise move in the August expiry as outlined in Futures Fireworks and Moral Hazards, so why should anyone be surprised one month later with this 50 basis point cut?

The Fed's move was not so much a surprise as the market's reaction to it. For those on the sidelines it was no big deal. For those looking the wrong way, it was. Still others are no doubt cheering like the CEO of Toll Brothers who proclaimed "Our boy has righted the ship". Please see Righting The Economic Ship? for a discussion of that idea.

But "Punishing Dollar Holders" has it limits. And Mr. Practical summed up the situation nicely in a recent missive entitled Minyan Mailbag: The Fed's Limitations. Yes, there is a limit. But no, we do not know in advance what that limit is. What we do know is that once the limit is reached, the result will look like the housing debacle only orders of magnitude worse. What's really amazing in all of this is everyone cheering Fed intervention in the free markets, when Fed intervention in the free markets is the root of the problem.