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This is a copy of Sy's weekly (weekend) newspaper column 'Being Street Smart', which appears in a few newspapers and on a number of financial Internet sites. You may post this as content on your own website as long as full credit is given exactly as at the bottom of the article.

BEING STREET SMART 

by Sy Harding

The Fed Needlessly Roiled the Markets This Week! December 14, 2007.  

When he replaced Alan Greenspan as chairman of the Federal Reserve last year, Ben Bernanke indicated he intended the Fed to be more open in letting investors and Wall Street know what the Fed was thinking in advance of its actions.

 That seemed like it would be a welcome change. Alan Greenspan was famous for deliberately creating what became known as ‘Fedspeak’, answering reporters’ questions and providing testimony to Congressional committees in such convoluted language that it did not reveal much about what the Fed was really thinking.

Bernanke’s openness has mostly been appreciated. Whether or not you agreed with what the Fed did, you pretty much knew what it was thinking, through speeches by Fed governors and Bernanke himself.

That was not the case this week.

Prior to its FOMC meeting on Tuesday it had been pretty much indicated that the Fed thought the economy was holding up fairly well, that it would let upcoming economic data guide its actions. While recent data has been fairly positive, analysts expected the Fed would cut interest rates by ¼% anyway, but more as sort of an insurance policy, and to throw the markets a bone. So when that was the Fed’s decision it was not a big surprise.

However, there was surprise and disappointment in the Fed’s statement that accompanied the rate cut announcement. In that statement the Fed said "information suggests that economic growth is slowing," and it deleted the language that had been in its prior statements, that it thought “risks to the economy are balanced”. The statement went on to say the Fed expected the ¼% rate cut “should help promote moderate growth over time”.

The already nervous market interpreted that to mean the Fed was acknowledging the economy is slowing more than it previously thought, but was still cutting interest rates only 1/4%. Worse, that it thought that would do the job “over time”, so would not be taking any further steps to give the economy a boost for awhile.

So the market plunged, with the Dow closing down 294 points.

It also created a flurry of criticism of the Fed overnight.

The next morning, Wednesday, before the stock market opened, the Fed jumped in with an unexpected and dramatic announcement. It said that, in coordination with four major global central banks, it will create a ‘Term Auction Facility’, which will lend at least $40 billion to financial firms that need it, in four separate auctions to begin next week. The Fed said it has also initiated reciprocal 'swap' lines with the European and Swiss central banks.

That announcement, indicating the Fed is indeed willing to do more to help solve the problems, caused the market to ‘gap-up’ at the open, with the Dow almost immediately up more than 250 points.

Traders and investors were livid. They had been blown out of bullish positions the previous morning when the Fed disappointed the markets by indicating it would not be taking any more steps to help the economy for awhile, which sent the market into a nose-dive. Then re-positioned for disappointed markets, they were immediately blown out of those positions the very next morning by the Fed’s reversal to a decision to do a lot more.

Indications that the Fed is not sure what it should be doing, and simply reversed direction overnight when markets didn’t like what it did with the rate cut on Tuesday, has left markets even more nervous than before.

We need help from Washington to prevent a recession, if it isn’t already too late. Stable markets would go a long way toward keeping investors and consumers more confident. But there is nothing markets hate more than uncertainty.

So there was harm done. Investors and traders can't operate in any markets under such conditions. On Tuesday bonds surged up almost 2% on the thought that the Fed will not be preventing a recession. If that encouraged any one to buy bonds, they had an immediate whipsaw, when bonds plunged 1.6% in the first hour the next day. It was the same in the gold sector, where gold stocks plunged almost 4% in Tuesday’s market sell-off. If that caused investors to sell or go short gold stocks they were immediately whipsawed, with gold stocks back up 3% the next morning, a whipsaw of 7% from one day to the next. The stock market plunged more than 2% Tuesday, and was back up almost 2% in the first hour the next morning. Even worse, the early gains on Wednesday did not hold even to the end of the day, as traders analyzed and grew increasingly confused and angered by the Fed’s actions.

In a difficult market where the S&P 500 is up only 4.5% for the year, and already had two back-to-back corrections of 10% just since July, this kind of game-playing won't create market stability.

The Fed’s actions were great. Its indecision was deplorable, and offset most of the increased confidence the actions could have generated.

I would almost guarantee that had the Fed made both announcements on Tuesday, that it was cutting interest rates 1/4%, and that it is creating a "Term Auction Facility" to assist troubled banks, the markets would have been very encouraged to see the Fed so decisive, so on top of things, so determined to provide support for the economy.

Sy Harding is President of Asset Management Research Corp., and publisher of the financial website www.StreetSmartReport.com, and the free blog www.SyHardingblog.com. He also authored the timely 1999 book Riding the Bear - How to Prosper in the Coming Bear Market, and 2007's Beating the Market the Easy Way - Seasonal Strategies that Double the Market!

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