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Is The Fed Incommunicado?

Author: Andrew Hart (info)
Website: http://bigtrends.com
Posted: December 21st, 2007 at 9:55 am EST
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One thing is certain? the shape of 2008 will contrast greatly with 2007.? Never in history have we seen such a credit crisis and the widespread affects across markets.? We’re not likely to see anything of this size or scope in our lifetime.? With fear and uncertainty looming, investors are looking for guidance from a different Fed with different communication styles.? After peeling back the layers of the onion, Fed officials and financials will realize it’s rotten to the core?the extension of credit issues will surely spill over into 2007’s hot sectors and countries.? By some measure, the Fed has all the power to keep this dip from becoming a full blown recession.?

Since market turmoil began in August, Fed watchers have built a track record for Bernanke’s first challenge and there are critics abound.? Most recently, a 25bp cut left investors dissatisfied and wanting more.? The problem may not be Fed policies but their communication of those policies with the market, what we’ve got here is failure to communicate.? Fed language has been focused and determined, or in other words, one-track-minded and stubborn.?

Bernanke’s Fed is vocal about inflationary concerns more than economic growth, which is fine in a bull market but unsettling during the current credit crisis.? Investors remain uncertain and fearful because the Fed’s language continues to warn against high inflation at the same time we are still in an undetermined market cycle. We are at the tipping point and investors are being pushed to the edge.? For example, in early August FOMC minutes took a strong stance on inflation (hinting at rate hikes) only to cut rates days later.? Investors were confused.? Again, in October the FOMC insisted that no more rate cuts would occur and in December we received another cut.? The Fed is working itself into a corner by tightening the language. In contrast, the Greenspan Fed used open but enigmatic language, and investors did find confidence.

It’s hard to talk about Fed policies, discount rates, and inflation without crossing the dollar.? It?s interesting to note that the dollar has been rallying, even with the latest rate cut.? Perhaps the inflation picture is real, and rates may soon RISE rather than FALL in 2008.? Fed watchers have been quick to note that Bernanke’s Fed is more hawkish than dovish, that is to say more concerned with inflation than growth.? Additionally, new Fed leadership is said to be even more hawkish?we could be looking at rate hikes as soon as signs indicate that the credit crisis is winding down.????

In the coming New Year chances of a recession have increased due to inflationary concerns, a disappointing stock market, and of course the credit crisis. The Fed is aware of these chances and should proactively act to stop further market declines. Further rate cuts may or may not be necessary, but loosening of language and overall improved communication with markets is mandatory. A pivotal point to change course would be now.

In technical analysis it?s been historically negative for the 50 DMA to cross below the 200 DMA, and it is very close to occurring in the next few days. Fed policy makers are more concerned with inflation than technical indicators, but the fact remains that we are more likely to experience losses than gains in the months after this event (January-March 2008). Since 1940 the 50DMA has crossed below the 200DMA 36 times. The market lost an average of .76% in the following month and averaged a negative return in the following quarter. On the other hand, in 2006, the last time the moving averages crossed, the market gained significantly in the aftermath.

While the market direction is virtually unpredictable today the Fed can “shepard” the market into a less volatile and perhaps successful 2008. Policies will be important; however, we learned that Fed language may be more important overall. Communication is key. Once investors stop receiving mixed messages and stubborn decries the market will guide itself. Once the market takes control with a supportive Fed we?ll have a better chance for growth.

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