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Saturday, October 11, 2008

The Fed Cuts

Many of your will have already seen this, but if not, you may find this chart on the Fed Rate Cuts interesting.



Note that when the Feds first raised rates in 2004, the trend of the rate rise is up - up - up - up - up ... etc. until it reaches the peak in 2006. Very consistent uptrend. Noone can missed it.

Then, when the Feds lowers rates from 2007, the trend is down - down - down - down - down - pause - down - down - etc. Again, very consistent downtrend. Some pauses here and there, but the trend is still generally down, although not much room to go. Again, noone can missed it.

If Fed rates are tradeable, buying on the first breakout in 2004, and selling on the first downside breakout in 2007 and reversing to short sale would have been superbly and extremely profitable. Anyone could have done so without training. **grin**

Another pattern to observe is that the uptrend usually takes longer than the downtrend, even though the Fed Funds Rate is not exactly tradeable.

Also, don't forget that "Law of Diminishing Returns" applies, in terms of the effects of the same rate cuts on the stock market. Initially, when the Feds first cut rates in 2007, the stock market cheered and rebounded quite strongly for a few days after the cut. However, the "temporary bullish effect" of the successive Fed rate cuts diminished as more rate cuts occurred. The latest rate cut of 50 basis point is a total "non-effect", in that the markets which previously closed higher after a rate cut, closed lower on the latest rate cut. Whilst some of these effects are due to markets expecting 75 basis point cut instead of the actual 50 basis points, it is also due to market realities and general principle that the first surprise usually have the biggest effects, and subsequent similar actions tend to be priced in by a greater number of individuals, diminishing its effects, so much so, that the latest rate cut was priced in by the largest number of individuals so far, that even after a rate cut, the market tanks.

At 1.5%, that's not exactly much more room to go lower. I'm not aware of a negative Feds rate, so, the maximum rate cut is 150 basis point, bringing it to zero. The question on everyone's minds now - besides when is the next rate cut - is will we see a record low Feds rate by the end of this year?

Also, found an interesting article a couple of nights ago on "How the Fed's Efforts to Lower the Fed Funds Rate may leave it Powerless to Stop the Financial Meltdown" here - http://www.moneymorning.com/2008/10/10/federal-funds-target-rate/ Linking it here for future reference.

Do give it a good read - in essence, we must always remember that the Feds rate is a "target" rate, not an actual rate, and the Feds rely very much on the Open Market Operations to try to achieve its target. Basically, in order to effect a lower interest rate, the Feds need to flood the treasury markets with lots of cash, so that when there is more cash chasing limited securities, the price of those limited securities goes up and the yields (interest rates) comes down. In essence, if after the first attempt to flood the markets with cash, the yields still haven't yet reached the target, they need to flood even more cash. And because this is essentially a "market operation", expects things like market fears, greed, and all the usual market factors to apply. In times like this, you can expect institutions who hold treasuries hoarding them and sell the other riskier things if they can, because treasuries are supposed to be the safest type of securities available. Also, besides flooding with cash, the lower interest rates require the banks to lend one another overnight, but if such lending doesn't occur, then, the rates might not go down immediately, and even more cash (incentive) is required to lower the rate. There is no doubt, it's more difficult in times like this, printing a lot more money will be required, and that's not going to be a pretty picture in the longer term. Expect volatility to be higher before it gets lower.

Nothing I've said is new. You can wiki "Federal Funds Rate", and get all this information too if you study them - http://en.wikipedia.org/wiki/Federal_funds_rate. These are all known factors and market patterns since a long time ago. The only question is will you and I remember all this in a few years or decades time when the same pattern repeats itself many years from now? *think* **grin **

Btw, the full Fed Runds Rate chart since July 1954 is shown below.


1 comment:

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