The LIBOR Holds the Key to the Fed
Having been involved in the markets for more decades than I wish to admit, I have learned that there is always something, some nuance or reading or indicator, that in retrospect was THE tell for what has occurred in the market or before a Big Bad Event (“BBE”) that the market is anticipating.Today, on the eve of the BBE, I believe the LIBOR may be telling that story. The LIBOR is trading at a premium of over 65 basis points to the current Fed funds rate of 4.5%. This is also almost 15 basis points higher than the LIBOR was trading at the August peak prior to the last 50/50 Fed cut in the Fed funds and discount rate.
Additionally, the spread between the LIBOR and the 3 month Treasury bill (the “TED Spread”) is far wider than it was at the time of the last Fed meeting. Add to that the recent rate cuts by foreign central banks, declining consumer sentiment and a Fed being pressured by our own bond market and I believe the Fed is caught in a rate cut box from which it cannot escape. I have previously made the case for an end of the year market rally and explained how the Fed would be the ultimate steward of that rally. I believe we are now at the point of ultimate resolution.
It is my opinion, based upon my previous discussions, the LIBOR relative to the federal-funds and discount rate, and the resounding need for liquidity into the financial system that the Fed will cut the federal-funds rate by one-half point and the discount rate by three-quarters of a point at their FOMC meeting Tuesday.
I believe these rate cuts will be accompanied by a statement reiterating that the FOMC does not currently foresee the need for any additional rate cuts, their bias is now neutral and equally weighted toward growth and inflation and they stand ready based upon evolving economic data to provide additional liquidity if required by the system.
This is the optimum resolution of the FOMC meeting from my perspective as a banker, lawyer, entrepreneur, private equity and hedge fund manager. However, as a student of the market I have tried diligently to approach this question from an academic perspective and believe I have done so with the data I have available. I am also fully aware that the FOMC currently has access to the PPI and CPI data due out at the end of this week. However, unless inflation has exploded to unforeseeable levels overnight there is no credible economic basis for the Fed to tilt their bias toward inflation.
I also realize that there is a faction within the Fed and among the private sector who believe no Fed intervention is required. Their preference would be to further observe the economy and weigh the conflicting objectives of promoting growth and containing inflation. The difference between this hawkish element and businessmen in my position is the Fed hawks are not on the front lines of the economy as I am on a daily basis. I am not an observer, I am a participant in this economy. I can tell you as a businessman with financial interests impacted every day by this economy we need the rate cuts I have described. We need them now and we need them to free up the credit markets that are bound by a lack of liquidity and a lack of affordable credit that allows us to make loans, borrow money and conduct business. While the rate cuts may not resolve all the problems the economy and the mortgage markets are facing they would certainly lessen the degree of pressure that is being exerted by market rates upon the credit markets daily.
In my recent series of articles regarding the Federal Reserve and the financial crisis created by the credit morass resulting from sub-prime mortgages and the financial sector’s exposure, I have outlined the various tools available to the Fed in dealing with this crisis. From surgical interventions to the blunt thrust of the discount window the Fed has a tool box of maneuvers available. My goal has been to highlight the Fed’s role relative to the data points that have been presented to them and the economic pressures with which they constantly are weighing and confronting. It is the relationship between the LIBOR and the TED Spread that should become a central focus point for the Fed in their determinations to be considered at the FOMC meeting today.
Be assured that over the decades, from Bill Martin to Art Burns, Bill Miller to Paul Volker, Alan Greenspan to now Ben Bernanke, the Fed has provided disappointments to the business community, the banking system, the economy and to myself. Perhaps it is the fundamentally academic frame of reference from which the Fed attempts to proceed or the lack of front line approach that businessman such as me are forced to operate within. But for whatever reason the Fed is notoriously infamous for delivering too little too late. We can only hope that on this critical occasion they will provide the stimulus necessary for this economy and the financial markets.
I am giving Chairman Bernanke and Vice Chairman Kohn the benefit of the doubt on this occasion and counting on their political skills to deal with the hawkish insurgents like Bill Poole and provide the half point cut in the federal-funds rate and three quarters point cut in the discount rate that is so badly needed by these markets.
But while optimistic I caution you to be prepared to be disappointed and align your portfolios in a manner that allows for the unexpected. Because if there is one constant that the Federal Reserve can provide, it is the ability to confound the markets and surprise the pundits. The LIBOR, the TED Spread and their relation to the federal-funds rate just may be speaking loudly enough to be heard this time.
Let’s just hope the Fed is listening.
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