Wednesday, March 21, 2007

Today's Bull Raid

There are a lot of folks in disbelief that the Fed switched its bias today to neutral. Granted, the Fed has created confusion by continuing to talk up the inflation risks, but it has removed the "firming" language. So just as Elvis is really dead, the Fed has done the deed and as left the door open to moving to an easing bias. To insist that because the Fed continues to talk up the inflation risks means the Fed did not change its bias betrays a lack of understanding of the constituencies that the Fed must play up to including world central bankers who look to the Fed to at least project an image of being vigilant about inflation. Remember the grief Bernanke went through during his first year on the job when there were doubts over whether he was an 'inflation fighter'?? There's just no way the language on 'flation would be toned down, especially after last week's PPI and CPI figures. And just briefly - the Fed is not flying in the dark. They know more than you think. While they are waiting for many pieces of 1st quarter data that you and I are also waiting for, they have droves of pencil heads crunching all sorts of numbers and looking at all sorts of things. Just go back through old minutes of past Fed meetings and read about the arcane yet eye opening things they are privvy to. If you think FOMC members are blindsided by dislocations and merely getting their data from tv land, think again. I also won't delve deeply into the political overtones, but did anyone really think Bernanke and Co were going to do anything that would send the stock market back into a tailspin and hasten the economy's trek to a recession while the White House deals with a war fiasco in Iraq and political battles inside the Beltway?

Greater disbelief tonight permeates through the shell shocked bear camps - I've been reading and hearing expressions of disgust, anger, bewilderment etc over today's bull raid. This was the Battle of Trenton Part 2, with the over confident bears (Hessians) drunk from recent celebration routed by a surprise bull attack today. Or was it a surprise? I won't go into the story of Colonel Rall except to say he lost that battle because he ignored a key piece of information. There have been some very interesting pieces of information that have popped up recently that have given me some understanding as to why the market has been able to bounce back on low volume- not the least of them the Fed repurchase or, REPO activity.

I've blogged about this repo activity in recent days as a red flag: billions has been poured in by the Fed to prop up the market. I've discussed how this money flows to primary dealers and how it can then be deployed to trading desks and how it can then be dumped into the futures markets which can magnify moves, though not necessarily trading volume. Voila - instant rally, or rebound. Perhaps the mistake that I made in not making the warning cogent enough was failure to include a picture. Here's a picture of the cumulative Repo activity:

Yeaah... that 950 is 950 BILLION smackaroos. I'm only addressing Fed repos, not even the stuff that Treasury is doing with Term Investment Options (TIO) which can also be at the billions of dollars per day level. Notice two key things on the above chart, generated by, A. repo activity has surged by nearly $50 bln in just the last few weeks and B. notice that repo activity went through the roof starting last June when the market was going through a period of tankage. Last June the Fed kept pumping the system until the end of the year and then they took their foot off the gas through early 2007.

My takeaway from looking at this stuff in recent days has been to be wary of stepping in front of the liquidity locomotive. The Fed holds the key to the money printing press and with the repo operations it can deploy cash through temporary loans that can help juice big market gains - just consider the extent of the rally up until February 27th.

Does this mean I no longer feel the Dow has a chance at going to sub-Dow 10k levels as I posted a few weeks back? I'm still in that camp, though as I noted earlier, technically we have a shot at the recent highs at S&P 1460, which is not too far off. The Fed's repo elixir will eventually meet its match given the extent of the problems the economy faces, the risk of a meltdown associated with over leveraged positions and the winds of change WRT to dollar holdings by Far East central banks. But for now it seems as if this repo stuff has worked and ignoring these indicators and becoming polarized to either a strictly bullish or bearish mindset in this volatile market will produce the 1776 Tom Paine lament, "These are the times that try men's souls."

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