Federal Reserve Action

OC-Cons.





I am not trying to stir the pot or play devil's advocate. As I stated before, I know very little about futures, bonds, and Fed rates and thus have little understanding of the forces that control them. I am simply putting out what I am hearing from the so-called "experts" in the field about what they see in the future and deferring to those who are more knowledgeable in the area, such as you, to comment on them. My opinions on the issues are simply what I can logically extract from the information and nothing more.





One of my concern is that we get too caught up in our mutual patting-on-the backs about how bad this market is and miss some opposing signs. That is what got homebuilders and homeowners into this mess (believing that housing prices/demand will stay high forever and ignoring the signs that others saw before the drop.) I am just trying to see all sides of this issue.
 
<p>Major ouch as rumors are hitting that BZH may be approaching bankruptcy. Damn these are interesting times!</p>

<p><img alt="" src="http://ichart.finance.yahoo.com/b?s=BZH" /></p>
 
IrvineCommuter,





No worries, this is a good discussion. Really, we are all just taking educated guesses as to what Bernanke and company (the FED) will do next. They have all the power.
 
<p>Even if I am wrong and the Fed lowers interest rates to stem the flow of blood Bernanke has very little wiggle room. Perhaps 50 to 75 basis points to move the fed funds rate. Any more than that will surely ignite inflation and further depress the dollar. A 50-75 bp move does NOTHING to alleviate the systemic problems in the housing markets. Again our system does work, as painful as it may be. Inefficiencies are dealt with in monetary terms. Supply and Demand find equilibrium eventually. Some, maybe many will lose their homes while others will eventually step in and buy at significantly lower prices. The market will eventually stabilize and prices will then rise again. But not for awhile. If you buy a home for the right reasons, pay a decent price, finance it responsibly and live in it a long time this fluxuation conversation becomes moot. Be responsible and you will be alright!!! </p>
 
<p>Inflation is an increase in the money supply, currently running at above 11% in the US. Inflation is not an increase in prices as is reported as the CPI or PCE. An increase in prices is the result or symptom of inflation, but it is not necessarily the only result. The money supply is increasing dramatically at present, yet prices of many items, (cars, tvs, clothing, etc.), are decreasing. The recent result of the huge increase in money supply has been the rise in home prices and other assets. Bernanke knows the difference between inflation and price increases. He knows what the real rate of inflation is, and the Fed decided to stop publishing M3, which includes a large part of the increase in money supply, in March of 2006. The Fed publishes the CPI as a mollifier to the herd so that the herd will not really know what is happening to their currency and their future purchasing power. Although Bernanke is concerned with inflation and the increase in prices, historically the Feds first priority is the economy and there are no new reasons to think this time is any different. BB is between a rock and hard place. If he raises the overnight, he wipes out housing further and sends the equities market into a tailspin. If he lowers the overnight, he is essentially telling all countries holding USD that they can go pound sand and we don't care what they can or can't buy with all the dollars we borrowed and used to buy their production. Bernanke will most likely do exactly what he has been doing which is to talk tough about inflation and mollify the herd and at the same time keep on increasing the money supply by buying US treasuries to keep the economy going.</p>

<p>Once credit is no longer expanding, it will not stabilize. It will contract. Credit contraction is deflation, which Bernanke will do everything in his power to preclude. He will expand credit as long as he can, inflation be d____d.</p>

<p> </p>
 
I remember a time when the announcment of M1 M2 and M3 moved the markets. Now they are a seldom followed indicator. Yen dollar exhange. Asian Tiger makets, Trade defecit figures, GNP then GDP. It is always a flavor of the month. And yet the economy chugs along. It absorbed a similar crisis in the late 80's with the S&Ls another credit crunch in 1997 with the Asian contagion and the implosion of Long Term Capital and the hedge funds. This too shall pass. I think housing is and will continue to correct but the economy will move on. This expansion tends to push inflation and the Fed will react accordingly keeping rates flat or maybe raising them a bit.
 
<p>"Fed won't ride to rescue of markets: Poole"...good article</p>

<p>http://www.marketwatch.com/news/story/fed-wont-ride-rescue-upset/story.aspx?guid=%7B265C021C%2D7EA7%2D401D%2DA60A%2D724EA859E758%7D</p>
 
awgee,





Doesn't the FED have limited power to control the money supply? With Japan loaning money at 1/2%, aren't they running the printing presses like mad over there? Doesn't the carry trade create money?





With the international flow of capital, the total amount of money in circulation is not fixed, and it is subject to the whims of central banks around the world. Am I missing something (I honestly don't know?)
 
<p>I would think the FED has to unlimited power to print money like there is no tomorrow, and it would also be transparent to the public. That is why I believe in something real, like "real estate". </p>
 
IR - As far as I know, the Fed can lower the overnight rate to 0% and the Fed can purchase an unlimited amount of treasury notes from the Treasury Dept. And there is no regulation or law limiting how much the Fed can create. One limitation is either the member banks willingness to borrow and or others willingness to borrow and lend.<p>




Yup, the JCB is "printing" money like crazy. Yes, the carry trade creates money. Correct, the total amount of currency in circ is not fixed. I am sorry if I implied otherwise. And, yes, the amount of currency in each country is subject to the whim of the CB within that country.<p>




Even though the Fed may create an unlimited supply of currency, it may not be in the best interest of the Fed to do so because the Chinese and Japanese CBs are holding $1 tril worth of USD notes and Saudi oil and other oil is traded in USD. If BB overtly prints money, he is overtly devalueing the USD and telling the CCB and JCB and the Saudis and everyone else holding USD, that we don't care if they can't buy squat with their USD holdings and we will not back up our currency. If you held a tril of USD and BB said he was going to devalue it, what would you do? Or if you sold oil in USD and he said he didn't care what a dollar would buy and he would not act to keep it valuable, and even do the opposite, what would you do? So, you see, even though BB is not limited by reg to limit the money supply, he is limited by practicality. I have to take my daughter to gymnastics. More later.
 
<em>"One limitation is either the member banks willingness to borrow and or others willingness to borrow and lend."</em>





Doesn't this become the ultimate limitation? I remember during the recession of the early 90's consumer spending dropped off because consumers were unwilling to borrow and spend and instead chose to save. If the meltdown of our mortgage market leads to a large-scale credit crunch, the FED could lower rates to zero and be unable to stimulate the economy because borrowers may chose not to borrow (no worries, Californians will always borrow .) I suppose if we lower are rates low enough, we could create our own carry trade and spend the next 10 to 15 years in a slow deflationary spiral like Japan.





Based on what the FED did in the wake of the S&L crisis, I don't think they will lower rates. The FED could have supported the commercial market in the late 80's the same way they could support the residential market now, but they chose not too. We took our bitter medicine and moved on.





Just to ponder the impact of lowering interest rates: oil has been rallying for months now based primarily on the declining value of the dollar. If the FED lowers interest rates, the price of oil will spike to well over $100 a barrel. The rest of the world won't be paying much more for oil because their currencies are moving up relative to the dollar, but our cost of oil will rise dramatically. It might even prompt OPEC to start settling transactions in EUROs instead of dollars. That can't be good for the US economy.





Also, China will sink into a deep, deep depression as its primary trading partner will no longer be able to purchase its goods. Prices will rise on everything, particularly things you buy at Wal-Mart that were manufactured in China (which is almost everything in the store). If China goes into a depression, the problem will go global.





I suppose our exporters will do well, but we are not an export based economy.





I don't see much upside to the FED lowering rates, other than for a few homedebtors who might be able to refinance their ARMs -- which of course they would do: right into another ARM. The cycle of perpetual low-rate financing is going to have to end sometime. It is just a matter of when, and how painful it is when it happens.
 
A video discussion about the topic:





<a href="http://www.cnbc.com/id/15840232?video=451582469">www.cnbc.com/id/15840232</a>





One expert say that the Fed will step in. Another say that it won't and even if it did, it would do no good.
 
<p>They're not coming.</p>

<em>"Economic growth was moderate during the first half of the year. Financial markets have been volatile in recent weeks, credit conditions have become tighter for some households and businesses, and the housing correction is ongoing. Nevertheless, the economy seems likely to continue to expand at a moderate pace over coming quarters, supported by solid growth in employment and incomes and a robust global economy."</em>
 
It's interesting to see how the market reacted. . . initial panic and then realization that it's no big deal. . . that will help make Ben's decisions easier.
 
<p>I don't know much about bond and it's relation to the Fed rate. </p>

<p>But here's a quote from Bill Gross of PIMCO: "The Fed needs to recognize is that at 5.25% it's a restrictive rate relative to a 4% to 5% nominal GDP world," said Gross. "Ultimately, they are going to have to cut rate." Futhermore, "The Fed needs to watch the markets but it also need to watch the economy.</p>

<p>Your opinion on this quote, please. I would like to learn.</p>
 
Cramer (love or hate him) believes that the Fed are setting up for a rate cut in October.





I tend to believe that the mortgage issues will settle down before the Oct. fed meeting and then hit new lows in the end of the year. This would have dramatic effects on spending as people are freaking out. . . bad Christmases. . .





So what will the Fed do. . . the calmer markets indicates that the Fed will stay but if there is enough pressure, the Fed may cave.
 
reason - My take, if the fed overnight rate is not accommadating or expanding credit, then credit will neccessarily contract. Credit expansion, a subset of inflation, is neccessary for an economy to show counterfeit growth if that economy is linked to a fractional reserve fiat banking system. If credit starts to contract, the federal reserve must inflate the money supply or inherent weakness in the economy will assert itself. If GDP is pronounced as 4% and the inflation indicator was accounted for at a 2% rate when real inflation was 6%, the real GDP would be 0%. Gross is seeing the contraction of credit and saying the Fed will need to reverse contraction in order to "grow" the economy.
 
The markets are finding stasis. The fact that Wells Fargo raised its jumbo fixed rates to over 8% is a correction within the credit markets themselves and assigne a premium to risk. This in turn will contract the availability of credit further. The yield curve steepens and returns to a normal slope. Higher interest rates happen without the fed raising a finger. Higher rates correct the housing market even more, reducing prices till demand saps up supply. Prices stabilize and the whole process starts over again. Probably around 2009 or 2010.
 
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