The Fed’s Possible Monetary Policy Direction

Posted on September 1, 2007 , filed under Stocks | Print This Post

The news propelling the market forward has been centered on Fed Chairman Ben Bernanke’s stance on being prepared to do what is needed, as this article is appropriately titled, to contain the subprime mortgage crisis from spilling over into the real economy.

I’m surprised by the aggressiveness of Bernanke’s remarks in his speech yesterday. In the speech, Bernanke commented [The Fed]…”will act as needed to limit the adverse effects on the broader economy that may arise from the disruptions in financial markets”.

Many investors are interpreting the comments as a direction for monetary policy changes. A growing majority of investors are now expecting an interest rate cut by September 18th of at least 0.25%. An interest rate cut should reduce the appeal of the USD as a currency investment. Short-term an interest rate rate cut should boost investor confidence causing the stock markets to rise. I believe the creation of liquidity by pumping USD’s into the economy and lowering rates is only prolonging the larger problem of the US economy being hinged on borrowing.

Jim Sinclair, a well respected investment analyst and president of Tanzanian Royalty Exploration Corporation [[TRE]] describes the situation succinctly on his website http://www.jsmineset.com.

I believe this article, The Hidden Reality, best describes the current situation.

Taken from the article:

People do not have a clue what is really happening. All the talk everywhere, even by well placed people without a bone to grind politically and economically, keep calling this a failure in sub prime loans. This is presented as if securitized bonds (with the assumption that the collateral for the bonds were mortgages themselves) has lost all its value. This is not the case. What is worthless is a the mix of credit and default derivatives that make up the vast majority of many instruments held by financial and commercial paper dealing entities, both private and public.

Even if you forget that the economic figures recently released are whoppers and take them at face value as commentators are, you still have to ask why the equities market fails to do better. The answer is simple. Rallies in the equities are presently being supplied by those that understand the grave nature of the present problem.

This is why the attitude of the Fed is not commensurate with the gravity of the global problem being caused by the meltdown in credit and default derivatives.

If it was simple mortgages it isn’t apparent because as bad as the mortgage market is they have not all failed simultaneously as if all sub prime mortgage holders have been foreclosed on at once. That alone should give you a hint that the problem is not the advertised, but much larger.

The Fed altering their banking regulations has to give you a hint that the problem is not the advertised problem, but much larger.

The financial difficulty going global has to give you a hint that the problem is not the advertised problem, but much larger.

When you see bank after bank needing liquidity in substantial amounts, this has to give you a hint that the problem is not the advertised problem, but much larger.

The hope for every central bank is that the real problem can be kept from public view. The truth is the public, even professionals in Wall Street, have no clue what the problem is. They know it has something to do with derivatives, but none realize it is a more than $20 trillion dollar mountain of unfunded, unregulated paper that has just been discovered to not have a market and therefore any real value.

Also taken from Jim’s website:

The problem with the rescue for both the Fed and White House action is:

1. The problem is three times the size of the entire US debt. It is OTC default and credit derivatives.
2. The problem is global, requiring a concerted and huge liquidity injection NOW.
3. The housing problem is pervasive and will continue.

If there is a result it will be temporary.

I expect to see a large pop in financial and precious metal stocks that have taken a beating. I will cover my current favored gold stocks in a later article. I am watching to see if major commercial banks Citigroup Incorporated. [[C]], JPMorgan Chase & Company [[JPM]], Bank of America Corporation [[BAC]] and Deutsche Bank AG [[DB]] trade closer to their 52-week highs to see if a broader medium-term rally is shapeable.

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