(Dolly Parton), Hard Candy Christmas...

By most standards the Fed headed by Ben Bernanke is still in its formative stages and as the clarity between this Fed's comments and its policy galvanize, unlike the often incomprehensible Greenspan days,  Ben Bernanke is quite a contrast.  Bernanke says he what he means  and when he says not to expect any rate decrease at the next Fed meeting on December 11^th, 2007, we are inclined to believe him (... in the word of Dolly Parton, "its like a hard candy Christmas).  The minutes of the October 31^st meeting indicated that the decision to reduce interest rates an additional 25 basis points was an uncomfortable compromise made in order to ease the mounting pressures from the financial markets that the Fed would cut rates.  The Discount Rate was cut by an additional 25 basis points to 4.5% from 4.75% (the rate charged between overnight bank-to-bank for lending).  At the same meeting, a decision was made to reduce the Fed Funds rate to 4.5% from 4.75% .  The vote was not unanimous and the Fed moved to a "neutral bias" in follow-up comments.  They make it very clear that they would not be forced to compromise their standards and that this concession to the capital markets was not likely to be repeated.

GDP: Key To The Fed's Next Move

We believe Ben Bernanke has little choice but to use the December 11^th meeting to demonstrate his convictions.  Accordingly, a bright line has been established and unless GDP growth, which is expected to fall between 1.8% and 2.5% in 2008, the Fed might give consideration to lowering interest rates.  The Fed GDP growth rate over the next 3 year years is 2.5%, which is well below the conventional estimates and the average experienced over the past 30 years (3.1%).  We doubt whether the requisite data will be available at the December 11^th meeting for the Fed to feel convinced to move on monetary policy.  In may not be until the first meeting in 2008, that the signs of a sluggish economy warrant any Fed intervention.  Insofar as December 11^th is concerned, the Fed may have to take a "pass."

The Risk Premium Differential Is Illustrating A Resistant Market

This market is not  giving a bullish signal - the risk premiums are advancing, suggesting that investors are wanting higher returns to invest in stocks.  In the short run we see no change in macro circumstances to precipitate a reversal of this trend.  In addition, we believe investors still hold out hope that the Fed will reduce interest rates again when they meet on December 11^th .  We take a dim view on the prospects of a cut in interest rates this time round (... and subscribe to the Dolly Parton view, "it's going to be a Hard Candy Christmas").     

• The Industrial Risk Premium ended at 6.35% versus 6.26%

• The Transportation premium rose to 7.30%  from 7.13%

• The Utility Risk Premiums declined to 5.59 % compared to 5.77%

The risk differential indices for the week ended November 23^rd, 2007 have confirmed a bearish trend that has been in place since early October. Notwithstanding some impressive rallies during the intervening weeks, this market cannot demonstrate a sustainable bull market, and this  is clearly demonstrated by the Risk Premium Differential trend's. n

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