Kevin Depew's daily Five Things You Need to Know to stay ahead of the pack on Wall Street:

1.  FOMC Playbook

Although everyone is focused on what the Federal Reserve Open Market Committee will do with the Fed Funds target rate this afternoon, the real action is with the Fed's Discount rate.
  

• Libor rates (the London Interbank Offered Rates) are at their highest ever to government rates. 
• Why? 
• Because banks either can't, or won't, lend to one another. 
• This is emblematic of what has been happening despite Federal Reserve repo market activity and three changes to the Fed's Discount rate since August 17; namely, that the liquidity the Fed has been offering is being absorbed by banks' balance sheets and not into the economy as it typically would through what is known as the multiplier effect. 
• Why do the banks need so much capital? 
• They need it to make up for the write downs they are taking on their mortgage-related assets. 
• As Mr. Practical noted in his article this morning, the bottom line is the banking system is seized up.
• The reason is simple: there is too much debt.
• The Fed's response, indeed it's only response available, is to create still more debt.
• Recently, San Francisco Federal Reserve President Janet Yellen (a non-voter) said she is disappointed that banks have not used the discount window. 
• "The discount window has not been as used, or been as helpful at addressing liquidity issues, as I would have hoped," Yellen said. 
• Why have they not used it?  Part of it is due to the stigma associated with borrowing as a last resort. 
• But it also has to do with the relationship of the discount rate relative to the Fed Funds rate.
• In 2003 the Fed raised the discount rate from 0.75% to 2.25%.
• This shifted the relationship to Fed funds from 50 basis points below to 100 above.
• "The Fed did this to move the patient from critical care to stable," Mr. Practical noted this morning.
• They may today move the patient back to critical care.
  
  CLICK TO ENLARGE
  Fed Funds Rate vs. Discount Rate, 1990 to present
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2.  Fed to the Rescue?

Before financial pundits get too carried away this afternoon praising the Federal Reserve's latest rate cut, let's take a look at what really happens to stocks when the Fed embarks on a series of rate cuts.   

The chart below shows Fed Funds rate actions (cutting rates in green, raising in red) overlaid against the S&P 500.  It's not exactly encouraging.

Click to Enlarge

3.  Market Performance Since the September Fed Funds Easing

Since August 18 the Federal Reserve has implemented three major policy actions affecting the Fed's Discount rate and two affecting the Fed Funds rate. 

The table below looks at how markets and select sectors have fared throughout those intervals and since the first change in the Fed Funds rate on September 18.  Note the dramatic improvement between the first Discount rate action on August 17 and the first combined Discount rate/Fed Funds rate action on September 18.




4.  Employers Scaling Back Hiring Plans

A couple of interesting things converging this morning.  First, we saw a Bloomberg article quoting Manpower's 2008 survey indicating employers have trimmed hiring plans for the first quarter of 2008. 
 

• Manpower Inc. (MAN) said its employment index for the first quarter of 2008 fell to 17, the lowest since the first quarter of 2004.
• "We've kind of pointed down a little, but we didn't fall off a cliff like we did in other downturns,'' Jeffrey Joerres, chief executive officer of Manpower, told Bloomberg.
• Bloomberg noted that Manpower's index dropped 8 points in the second quarter of
  2001, the start of the last recession.
• Still, employers in five of the 10 industries polled by Manpower said they planned to limit hiring next quarter.
• Not surprisingly, the hiring outlook was weakest for construction companies.

5.  Correlation Between Unemployment and Mortgage Delinquencies

Second, while listening to the Genworth Financial (GNW) call we were reminded by management of the historic correlation between unemployment rates and mortgage delinquencies. 
 

• CEO Michael Frazier said Genworth "did not expect the speed or degree of the unprecedented turn of the housing market." 
• What is interesting is the degree of divergence between unemployment claims and delinquencies.  
• The chart below from the Genworth presentation shows the confluence of factors that are working together in the current  housing situation. 
  Click to Enlarge
  
• Given the longstanding correlation between delinquencies and unemployment, there is little wonder the Fed is feeling pressured to utilize all policy tools to avoid slowing economic growth. 
• With adjustable-rate mortgage resets not scheduled to peak until mid 2008, it doesn't take a lot of imagination to visualize what will happen if even a modest recessionary slowdown materializes.