With Ben Bernanke conducting the Federal Open Market Committee (FOMC) movements, their short-term interest rate decision will reverberate throughout the world on Wednesday, April 30th at 2:15 PM ET. The FOMC has cut rates no fewer than six times in last eight months, so another cut would be their seventh, bringing the fed funds rate below its current 2.25%. Here's a graphical illustration of fed funds rate back to 1954: http://en.wikipedia.org/wiki/Image:Federal_Funds_Rate_%28effective%29.png
The psychology of their call will be based on a mixed bag of data, therefore we bring you: "The Good, the Bad and the Ugly". The good data the FOMC will consider is two pronged; the strengthening dollar and the strengthening S&P Index. The S&P has sprinted 10% from its March lows, just weeks ago! This is a very positive development as the broad stock market is the best scientific predictor of macro economic conditions.
You’ll notice that the S&P Index is set to break through a critical technical resistance at 1,400. This very bullish development will be mentioned on Bloomberg, CNBC's Morning Call, Dylan Radigan's Fast Money, and Jim Cramer's Mad Money as "the market is climbing a wall of worry". Many will mention crude oil as the major hindrance and a sudden bursting of the crude oil bubble would have detrimental affects to stock market bulls (we know Jim Cramer agrees with us on this point). Why? The oil market is being used as a safe haven parking lot for many Institutional funds. Not too many sectors have done so well, and if it wasn't for the crude oil rally, the S&P Index would be much lower. Bubbles are good in that someone is making a lot of money, and eventually those profits will rotate to other asset classes, yes? Commandment ~8~ states there are two sides to the market; so try to analyze bubbles with more positive psychology, okay?
The second good bit of data the FOMC has is the stabilization of the U.S. dollar (greenback). Many economists predicted the greenback would continue its free fall after the last 0.75% (75 basis points) cut on March 18th, but they have been proven wrong so far. The greenback has raised its rebel head, and is now looking forward, from above the 50 day moving average: http://quotes.ino.com/chart/?s=NYBOT_DX
Those are the two good nuggets conductor Bernanke and his FOMC orchestra will consider in their two day ensemble starting Tuesday. Now to address the bad and ugly skeletons.
The Michigan Consumer Sentiment, released Friday, April 18th, hit the lowest level in a quarter century: bad data. The psychology of the consumer remains extremely pessimistic: http://www.msnbc.msn.com/id/24066413/
The problems related to the housing and the credit crisis drag on and on and on, therefore this bad data will be included in the FOMC's notes. No one knows just how much this negative consumer psychology will influence Bernanke's orchestra. We believe there will be one dissenter in the final decision, and if that scenario occurs, the market could stumble. Wall Street hates uncertainty, so when the Fed isn't harmonious in their decision, sell offs follow. Maybe the FOMC will follow the Three Musketeer motto and prove us wrong: "One for all, and all for one".
Finally, the ugly reality of inflation in the continuing trend of rising food and energy prices, especially crude oil prices. At $117.00 a barrel, crude prices are up over 30% since January of this year alone.Quick psychology: In 1954 American cars were heavy, made of solid steel, yet a barrel of crude oil cost $2.90. That’s cheaper than a single gallon of gasoline today! Of course that's not adjusting for inflation, but its mind numbing nonetheless. Few widely held assets have appreciated 4,000% (40X) since 1954. This development with crude oil is the ugliest note the FOMC must play in their concerted effort of attempting to strike that perfect harmony; not too loose/dovish/low, and not too tight/hawkish/high. Some economists argue further interest rate cuts could contribute to inflationary pressures, outweighing the benefits of potential growth that "cheap money" (lower interest rates) offers. Since consumer sentiment is so negative, we argue two more 25 basis point cuts could destabilize the good data, especially the greenback. Remember, a weak greenback is good for multinational blue chips exporting goods and services over seas. But nonetheless, consumers unrelated to Wall Street profits cannot afford to see the greenback fall and exacerbate inflationary pressures on everything we buy, especially gasoline.
With the good, the bad and the ugly elements having been addressed, how many feel the FOMC will strike the wrong chord in the markets come Wednesday? Perhaps they will do the right thing and leave the remaining bullets in their chambers, for potentially uglier days ahead? Taking too many quarter point cuts could bring us to a bloodied zero short-term rate rather quickly. Zero is one number that does not allow itself to be divided by anything, including the best mathematical modeling software on Wall Street. Ironically, a zero fed funds rate would signal the end and a new beginning at the same time, ringing in a paradigm shift in monetary policy. A zero fed funds rate shows tremendous macro economic weakness and would have disastrous effects on Wall Street Investment Banking and no doubt the consumer as well. Could the U.S. economy be in such jeopardy for rates to drop to zero, or even below zero, causing a "liquidity trap" like that which occurred in Japan in 1998? We surely don't think so: http://money.cnn.com/1998/11/06/economy/japan_bank/
The Japanese Nikkei was hitting 16 year lows during their 1998 banking crisis. Our S&P 500 would have to fall 400-450 points to reflect similar psychology. It won't happen: http://stockcharts.com/charts/historical/Print/SPX1960print.html
The S&P Index climbing above 1,400 will signal resounding bullishness, so we feel things are not as gloomy as perma-bears would have you believe. Therefore, the week ahead will be a testament to the resolve of the U.S. stock market and foretell positive economic conditions, sending the bears into hibernation as the S&P closes above 1,400 on Friday May 2nd. Statistics show the U.S. economy remains the largest of any other country, so the rest of the world’s investors are watching and hoping the credit crisis finally be laid to rest.
POTC believes the strength in foreign currencies, especially the Euro-dollar will act as a fire starter for high end real estate, particularly coastal and prime urban cities like Manhattan and Chicago, along with blue chip stocks like Goldman Sachs (GS), Genentech (DNA), and Intel (INTC). POTC envisions these buy out/scenarios unfolding by the time the leaves turn color and Fall. Euro-dollar buy outs are on the horizon, so fasten your belt, especially if you're selling short the wrong stocks. If the saying "sell in May and go away" comes true this year, we suggest you take advantage of that set up, especially in blue chips mentioned above. The Fall season will be marked by major Euro-dollar buy outs of U.S. based assets. Could the fire sale ahead be the reason the S&P Index is breaking above 1,400?
The FOMC would be wise to give serious consideration to the recent strength in the S&P Index as well as U.S. dollar. POTC feels director Bernanke's orchestra should hold the notes steady at 2.25%. The crescendo for a 25 basis point cut is building at the Chicago Mercantile Exchange, we know, but we feel the FOMC should not chance an impromptu climax, desperately rushing to that dreaded number zero. A climactic sell off from the key technical level of S&P 1,400 will be avoided in our opinion; still the decision looms. No dissenters, and no bloody ‘Wild West’ endings please. We hope director Bernanke is bold, keeps fighting, but exhibits more patience. Leave the melody unchanged and keep the powder dry. Here's a relief video that ties our good, bad and ugly piece together. Please watch it in full screen mode: http://www.youtube.com/watch?v=ZKlxyoPNaFI
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The Psychology of the Call team.
This article is dedicated to one of our friends, who is a genius of bond market mechanics and a virtuoso jazz pianist as well, go figure!! Hats off to you, Paul~