"Don't Fight the ECB" lacks the alliterative quality of the Marty Zweig formulation, but at this critical market juncture it may be even more important.
The hot money traders, doing something to score at year's end, have reacted vociferously against the Fed. Equity traders understand big rate cuts, and that is what they wanted to see from the Fed. Those taking an analytic perspective -- mostly economists -- have a different viewpoint about what the central banks are doing. Mark Thoma's excellent blog, Economist's View, cites an interesting article by Kenneth Rogoff explaining the difference in perspective between traders and central bankers. Prof. Thoma also highlights some breaking news:
"The European Central Bank announced it would offer unlimited funds at below market interest rates."
The Contrary View
Most US equity traders are taking a very different viewpoint. The regular market letter from John Mauldin is distributed to over one million readers. This week he cites commentary from John Hussman about Fed policy. Hussman's point is that the Fed auction, the ATF, is not actually adding liquidity. It is offset by a reduction in regular Fed operations to control the monetary base.
This explanation is correct, but misleading. The point of the central bank operations is not directed at an overall increase in the monetary base. It was never depicted as such. There are two principal objectives, which we have highlighted during this period of turmoil:
- Accept a wider range of collateral. This is like the discount window at a lower interest rate.
- Address high LIBOR rates by introducing agreements between the Fed and European Central Banks.
Any source that is not explaining all of this is providing only part of the story.
We recommend reading Econbrowser, for a solid and unbiased analysis of these developments.
Our take is that most US equity traders are not willing to analyze the complexity of the situation. There has been a knee-jerk reaction that the Fed is out of touch.
This is incorrect. The Fed and the ECB are on the case. While the announced initial actions may seem modest, the banks will continue to act until LIBOR responds and illiquidity in mortgage securities has been addressed.
The market has inferred too much from a 25 bp cut versus 50 bp. It was not an indication of commitment. The banks are bigger than traders. Do not fight them.