It came down to one of two scenarios as I noted in my "Market Outlook" section in the right hand column on 9/16: either a melt up with a 1/2 point cut, or a melt down from a paltry 1/4 point cut. The Fed blinked and returned the punch bowl to the table with a 50 basis point decrease (1/2 point) in both fed funds (to 4.75%) and the discount rate (to 5.25%). Banks rapidly followed suit and cut their prime lending rates by a 1/2 point to 7.75%. Yes, the cure from Dr. Bernanke et al for too much easy credit that is at the root of the problems we face, is to lower interest rates!
The stock market loved the big rate cut after begging for it. While volume got back to about normal (remember the market only had about 1 hour and 45 minutes to react to the news), breadth was remarkably strong with unprecedented advancers of 3,015 stocks versus just above 300 decliners. That was a 10 to 1 ratio in favor of rising stocks today.
Stocks have moved into breakout mode by busting above what had been resistance zones in the S&P 1500 area and the Dow 13,500 region. It's a market that doesn't want to discount anything, apparently. As ridiculous as this sounds, there is a possibility that we could retest the July highs. But time is of the essence for the bulls to do that and with each passing day the odds increase for more 'bad' news to shake world markets. The question really is, 'how long will the rally last'?
To answer that question, do I dare delve into what happened to the stock market during the last rate cutting campaign that started on January 3, 2001 as the economy moved into a brief recession? Will this turn out to be a situation of the market regretting what it had so fervently wished for? After all, the Fed doesn't ease just for the fun of it, it eases in response to deteriorating economic conditions, or other sudden market disclocations. We have both in play.
Back in 2000 the Fed had lifted fed funds to 6.5% by May of that year and then paused for 7 long months at the dot-com bubble unraveled. Many faulted Greenspan at the time for waiting too long when the Fed started lowering in early 2001. But then there were rate cuts at every Fed meeting during 2001 which got fed funds down to 1.75% from 6-1/2. Then one cut in 2002 and a final cut in 2003 that got Fed Funds down to 1%. How did the stock market fare? Here's a Dow chart for that period of time...
Yep, even with fed funds down to 1.75 by the end of 2001 and then 1.25 by November of 2002, the market got pole-axed -- not reviving until early 2003.
It will be interesting to see whether history will be repeated. Todays rate cut, if you read between the lines, is an admission by the Fed through its action of a 50 bps cut that it is dealing with both recession and systemic risks.
That brings me to mention the dollar which swooned today - hitting a record low against the euro at near 1.40 and slumping in the basket of currencies known as the dollar index. When the Fed started cutting rates in '01, the dollar index was perched at 107. Today it finished at 79.22! The forex judged the move by the Fed as a big mistake, at least where the dollar is concerned. Has the Fed set the stage for an insidious sort of arbitrage where money will flee away from the U.S. and into higher yielding assets?
The monthly Treasury International Capital report, known as TIC, showed international investors bought a net $19.2 billion of long-term U.S. securities in July. That's way below the $97.3 billion in June. This will be the key report to eye each month. The implications of weakened inflows of foreign money into long term Treasurys will have a profoundly negative impact for Uncle Sam and for you and me.
A Barclays report summed it up this way: "With foreign investors holding a quarter of all outstanding U.S. government bonds, the possibility that Fed easing will reduce foreign appetite for these securities, resulting in higher risk premium for U.S. assets and a weaker dollar, is very real in our view."
With a weaker dollar, comes reduced spending power, or inflation. The gold bugs loved today's rate cut and sent the October futures up to the $724 level. A weaker dollar also impacts the price of crude oil since it takes more weaker dollars to pay for it. Crude is trading above $82 tonight.
Option open interest has never been higher, the next fun event for the market --quarterly expiration on Friday. More on that tomorrow.
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