Fed Moderation

So today was Fed day and the market listened to the old geezers and said in so many words, "you are wrong!" Essentially the market was indicating that the Fed's worry about inflation is yesterday's news. Why? Well, perhaps a $27 fall in the price of crude or a $.25 cent fall in gas prices over the last few weeks was a supporting point for the equity bulls. Or how about gold not making any headway higher during this move in crude in 2008. Lastly, have you seen the collapse in grain prices? Add this together with a moderating PCE and just perhaps the Fed has got it right to some extent.

Of course, lets get real. The Fed had to lower rates to 2% because they ignored what was going on in the credit markets. The White house claimed everyone should own a home and wall street obliged - meanwhile Greenie printed money and the housing and credit boom began. Today we are dealing with that and while we may all be happy about a Fed that may be finally getting something correct, at the same time, it is this Fed that helped with the predicament. That aside, lets take a quick look at the statement.

First, inflation is being spouted as an concern. Dallas Fed Gov Fisher, he of the 8th inning talk a few years ago, dissented today in the 10-1 decision to keep rates steady - he wanted higher rates to 2.25%. Perhaps a case could be made for that now given the fact that fair value of the overnight target still resides around the 3.75% level or about 1.75% higher than we are today. Conversely, my 2nd round effects indicator, which is a measure of pass through inflation to wages, is negatively correlated. What does that mean? Inflation is not passing through to prices and margins are being squeezed. So on one hand, there are no 2nd round effects. On the other hand, profit margins are being squeezed.

Another point to emphasize from today's notation to the marketplace is the Fed's belief that there is still considerable amount of stress in the marketplace. While that is true on the banking side as many regional banks are having issues, the broker dealers are not borrowing from the window anymore as shown by recent data. They were having the issues before and now are offloading those problems for .22 on the dollar (thank you for the bottom Merrill Lynch). By the way, if my mortgage is selling for .22 on the dollar, can I go buy it? Just food for thought.

Lastly, something to consider here is the dollar. As I have been arguing consistently, the dollar is perhaps on the verge of an explosive move higher. When Euro 1.50 is taken out or the Aussie, Loonie and Swissie start to weaken quickly, we could see a quick down 50 points for gold and another $25 for crude. Further, if the dollar index breaks past 75, I am looking for 80, which implies about $1.35 for the Euro. Aside from this, a stronger dollar does a few things for the Fed. First, it should lower import price inflation. Second, it should drop commodities on their face, which implies lower inflation. Finally, it could lead to a stabilizing housing market as people buy assets in the US expecting appreciation - that is something you probably have not heard in 6 years! This should loosen up the financial system and have the Fed raising rates with rising growth levels - generally a good environment for the dollar.

So the bottom line is simple. With inflation pressures coming down, my second round inflation indicator now negative and overall price levels in the marketplace backing off, combined withe beginning of what could be a big dollar rally, I think the Fed could be on hold for a while. Oh, did I mention that easy policy generally with rising growth is good for stocks? When stocks finally find some footing (tech is somewhat showing that), then the Fed will get into gear. Till then, Bernanke and company are probably on hold through the rest of the year.