Will Boom Boom Carpe Diem?
What if our maligned Chairman seized the opportunity to not lower rates at all?
As they typically do, such transparently disingenuous public debates not only disregard the dangerous bi-products of their rhetoric, they also ignore their unintended consequences, which in this case consist of injecting into the financial markets yet another layer of uncertainty – of the political kind in this case – which is precisely the last thing that skittish financial operators want to incorporate into their already shaken thoughts.
Leaving aside for a moment that the Fed already knows it has no graceful way out of the current box, I would argue that any added pressure on Boom Boom will only result in him adopting a posture that will be deemed unfair and/or wrong by the largest number of people, which by extension can then be defended as fair and proper precisely because it peeved everybody off in equal parts.
My sense is that Boom Boom would achieve this by cutting the Fed Fund rate by a lowly 25 bps. The fed would have cover for this measure by having reacted in similar fashion to the 1998 Long Term Capital "issue". The mass media has already declared our current conditions as analogous to 1998, hence - right or wrong - who are we to argue with them. And besides, intuitively it is not such an outrageous analogy, at least as it pertains to broad financial measures:
From Jan. 1, 1998 to the closing low on Aug. 31, 1998, the S&P 500 lost 1.35%
From Jan. 1, 2007 to the closing low on Aug. 15, 2007, the S&P 500 lost 0.8%
From the market high of July 20, 1998 to the Aug. 31 low, the S&P 500 lost 19.15%
From the market high of July 19, 2007 to the Aug. 15 low, the S&P 500 lost 9.4%
From Jan. 1, 1998 to the date of the Sep. 29, 1998 rate cut, the S&P was up 8.1%.
From Jan. 1, 2007, to date the S&P is up 2.5%.
On Aug. 31, 1998 – the first low – the VIX peaked at 45.
On Aug. 15, 2007 – the current low – the VIX peaked at 37.50
On Oct. 9, 1998 – the retest low – the VIX peaked at 49.50
For 3Q and 4Q 1997, and 1Q and 2Q 1998, GDP growth was below 2% each quarter.
For the last four quarters GDP has averaged 2.75%.
During the 1998 crisis the Dollar Index (DXY) fell about 11% and bottomed at 90.75
During the current shakeout the DXY has hardly budged, but still sits at a 20 year low.
On Sep. 29, 1998, the fed fund target rate stood at 5.5%.
Currently the fed fund target rate stands at 5.25%
At the regular Fed meeting of 9/29/1998, the Fed cut the rate by 25 bps.
On Oct. 15, 1998, option expiration Thursday, the Fed did an inter-meeting cut of 25 bps.
By these yardsticks it is fair to say that so far the picture does not look nearly as dire as it did in 1998, and therefore something more than a 25 bps cut on Sep. 18, would seem unjustified, and rather panicky, Bob Toll's whining notwithstanding.
Of course Minyans know that qualitatively today's problems are dramatically different from 1998. Back then, the LTCM debacle resulted in a liquidity crisis, as highly leveraged strategies went bad and margin calls started snow-balling. The catalyst for the meltdown was the leverage in the positions, not the credit quality (credibility?) of the positions, as most of LTCM's games were being played with government debt. Plus the problem was containable within LTCM.
Today, the size of the mess is exponentially larger, and at its root is not a poor investment strategy, but the creditworthiness – or lack thereof – of the underlying debt. And in the name of diversification, the toxic-debt waste has been evenly distributed across the planet, often slipped into unsuspecting portfolios whose approach to due diligence consisted of... nothing because whatever was being bought was way too complicated to be understood, and/or managers did not even know what they were buying. So, unless one embraces the view that throwing good money after bad credits – literally speaking - is a sound approach to curing bad debts, no amount of fresh money from Boom Boom is going to make any difference, be it in 25 or 50 bps increments.
Which brings me to a "carpe diem" / "Black Swan" kind of possibility being served to Boom Boom on a silver platter: what if our maligned Chairman were suddenly endowed with stones worthy of a Fed Head, and he seized the opportunity to not lower rates at all? What if he pulled a "Paul Voelcker" on reckless lending? Could it be that after the painful (very painful) purging of ten years of excesses, and probably a fairly steep – but anyway unavoidable – recession, he might prep the economy for another Reagan-esque boom period? Or is the financial structure too far gone at this point to survive such a shock?
Of course I do not have an answer for you, except to suggest that flipping the "Fed In A Box" visual on its head, we could re-title it "The Fed's Got Nothing To Lose" approach. Remember Minyans, "Boom Boom looks in the abyss, there's nothing staring back at him. At that moment Boom Boom finds his character. And that keeps him out of the abyss."
...At least until the next round of commercial paper fails to roll-over.
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