Why the Fed May Not Be Done

Includes: DIA, IEF, SPY
by: Bob Lang

April 30 may have been a watershed moment for the Federal Reserve and Ben Bernanke...or, maybe not. The Fed cut the funds rate once again, this time a measly 1/4 point. The instrument has become more blunt, and may have been removed for the equation altogether. However, there is some anecdotal evidence that points to continued aggression by the Fed. They would like to make sure the economy is on good footing before sounding the 'all clear'.

The Devil Is in the Details

The Fed has done a better job explaining its actions. In previous regimes, the ambiguity and vagueness were so apparent that one could barely figure out any posture. Bernanke and Company may have been late to the party, but make no mistake...their intentions are well spoken and very clear. From the release:

Financial markets remain under considerable stress, and tight credit conditions and the deepening housing contraction are likely to weigh on economic growth over the next few quarters.

This tells us the Fed is still very worried about the affects of the banking crisis, housing mess and credit crunch. This deadly trio is so overwhelming that the Fed may not only cut more, but may keep rates LOW for a very long time to come. This of course is not a precedent...but is still quite dangerous. The credit markets have not loosened up, on the contrary... lenders have become reluctant to lend to businesses, while home equity loans are being locked up or reduced to protect equity that continues to deteriorate. The big issues are housing, spending and jobs and the Fed is all to aware of it:

Household and business spending has been subdued and labor markets have softened further.

Clearly the Fed's concerns have to be resolved, and while a pause may be on the table, they will certainly come out with guns blazin' if the monetary and fiscal stimulus fail to restore order.

History Should Be Our Guide

We get our best chance to predict future action by looking at past behavior. This Fed, while slow to respond...is really no different than past Feds. Often late to the party, they will hang around 'too long' and precipitate problems at the other end of the spectrum. We saw Greenspan's Fed overshoot and kill growth back in the late 90's with a series of rate hikes...that squelched growth. In 2002, the same Fed cut rates to the absurd level of 1% and left them there for an extended period, fueling the subprime crisis and other credit issues. Easy money policy can have long lasting negative affects...a weak dollar being one of them.

Going Forward

The Fed may be done with their historic rate cuts, but maybe not. As always, time to monitor each and every economic report, scrutinize them and discuss. The 1st Quarter GDP and inflation numbers allow the Fed to remain aggressive, and a weak employment report would pretty much solidify the stance. Where to go for trades? Right back to the profitable ones from last month...agriculture, oil, metals, coal and gold.

Disclosure: None