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Five Things You Need to Know: Fed Faces the Limits of Confidence


For a body whose very authority and effectiveness is predicated on Faith & Optimism, a lack of confidence is bad news.


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

Bloomberg News this morning ran a piece on how the "failure" of the Federal Funds futures market to predict rate moves is "undermining confidence." Well, shucks. They were right. Barely an hour after that article appeared, The Conference Board reported that its Index of Consumer Confidence has plunged to its lowest level since the group began keeping monthly records... in 1967.

I wasn't even born in 1967, but I've seen enough television to know that a lot of grim, heavy stuff was happening. Jimmy Hoffa was in prison. The first Super Bowl was played that year, kicking off an annual wave of wife beating that continues to this day. Our spaceships were blowing up on the launchpad. And the Doors' released their first album, featuring an endless 11-minute Oedipul-song of doom titled, "The End."

"This is the end
My only friend, the end"

Surely, I must jest. And I do. The Fed Funds rate is barely related to "consumer confidence" in anything but the loosest, most ridiculous sense; similar to the way a beer tap is related to a Billy Club.

It is doubtful most people living in the 5,000 some-odd households surveyed by The Conference Board even know what the Federal Funds rate is, much less how the Federal Funds futures market relates to it. But so what. Those 5,000 households are agitated and restless. And when your job is predicated on Faith & Optimism, as is a central banker's, the last thing you want to deal with is an agitated horde of humanity that 1) doesn't really know with any reliable conviction what it is, exactly, that you do, 2) but, nonetheless, believes with deep certainty that, whatever it is, it causes them to be richer or poorer, and 3) is nearing the point of believing 1 is irrelevant and 2 merits a savage beating.

"This is the end
My only friend, the end"

Heh. Just kidding, Mr. Chairman. It is true, you were too busy studying for the SATs in 1967 to be listening to such grim, profane lyrics. Quod erat demonstrandum.

But enough of that digression. Where were we? Yes, the Federal Funds futures market. There are clear reasons why the Fed Funds futures are not reliably predicting the Fed Funds and those reasons are all related to the ongoing stress in credit markets.

The Fed, under ordinary circumstances, "helps" bring the actual Federal Funds rate, the interest rate at which (formerly) private banks lend reserves (federal funds) to other (formerly) private banks overnight, via "open market operations."

The Fed has dramatically expanded their lending, and by extension the supply of bank reserves, which is showing up in the "effective" or "actual" Fed Funds rate.

Before anyone spends much time mapping out how the stock market may react to the Fed's rate cut decision tomorrow, consider the following chart which shows the close adherence of the actual Fed Funds rate to the Target rate.

"Normal" Fed Funds Target (Red) versus Actual (Blue) June 06 - June 07
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Normally, the effective rate trades in a pretty close range to the target. Recently, the effective rate is trading far below the target rate, however:

Fed Funds Target (Red) versus Actual (Blue) July 07 - Present


Whatever the Fed does tomorrow, 50 basis points, 75 basis points, will simply be an attempt to bring the target rate down to reflect some semblance of reality.

Then, next week, when the financial television channels and media discover that interest rates in the real economy have not moved, or perhaps have even moved in a direction opposite of the Fed Funds target rate, there will be a preponderance of bearish sentiment about how the Fed rate cuts "are not working."

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