No, yes; No, no; Maybe or maybe not! Is that clear?

As noted in our previous comments, Ben Bernanke is still in his formative stages.  We commented that perhaps, unlike the often incomprehensible Greenspan language, this Fed Chairman would strive to bring a heightened degree of  clarity between this Fed's comments and its polices.  We concede defeat.  At the inception of Bernanke's term and, especially in the early stages of the financial crisis, our impression of Ben Bernanke was that he played it "fast and lose." We believe our original view may have been correct after all.  We reverted to our original thinking this past week based on the following course of events. Early in the week, market expectations were running low that an interest rate cut  might be forthcoming. But by mid-week, Don Kohn,  Bernanke's deputy began to address tensions in the financial markets in a speech on November 28^th, where he was quoted as saying,  "In response to developments in financial markets, the Federal Reserve has adjusted the stance of monetary policy and the parameters of how we supply liquidity to banks and the financial markets." Kohn went on further to  comment that the Fed acknowledged at the October 31^st meeting that, "...uncertainties about the economic outlook are unusually high right now. In my view, these uncertainties require flexible and pragmatic policymaking--nimble is the adjective."  Quite a departure from the summary of the December 11^th meeting minutes and the hawkish views expressed by two other Federal Reserve Board members just days before Kohn's speech.  Serious policy repositioning began the next day, November 29^th in an otherwise commonplace speech Bernanke reiterated the Fed's concerns over inflation risk from food, energy, and import prices.  He also stressed the point that there was a significant amount of important information still to be released before the Fed meets on December 11^th, especially the critical labor market report.  But then Bernanke swung the door right open, by laying out what would lead the Fed to cut rates (...where did this come from?).  The Chairman gave a clear signal that the Fed would consider reducing interest rates if three conditions are met (no clarity on whether it's all or nothing):

1. Financial markets remain distressed

2. The risk to inflation does not increase and

3. The remaining economic data do not come in stronger than expected.                                                                                           

Reversal in "policy" or "rhetoric" to soothe roiling financial markets? On balance, Kohn's speech stressing the Fed's concern for orderly financial markets served as the ideal curtain-raiser for Bernanke's main act. If not conflicting enough, Gross Domestic Product (GDP) "figures released the following day showed a 4.9% rate of growth in the quarter, " nearly twice the Fed's maximum estimate for a sustainable rate for the U.S. economy.  The White House, meanwhile, was not immune to this interest rate chatter and published a revised 2008 economic forecast, predicting a 2.7% rate of growth -- just 2.2% above the Fed's objective but, more importantly, de-facto eclipsing  the GDP figures set by the Fed needed to justify reducing rates at the upcoming meeting.  The Fed has maintained a bright set of GDP growth parameters, specifically, if GDP falls to between 1.8% and 2.5% in 2008, the Fed would give consideration to lowering interest rates.  Over the next 3 years, the Fed's GDP target expansion rate  is 2.5%, 

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 have made 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.

By laying out a plan for lowering interest rates at the December 11^th meeting, the Fed has fuelled expectations of a cut of at least 25 basis points and we have seen estimates as high as 50 basis points.  We think it is safe to conclude that they have wedged themselves into a very nasty corner.  The market is starting to believe that a rate cut will be a reality and this market is much too fragile to handle a game of "fact or fiction."

The Risk Premium Differential Has Made A Modest Bullish Reversal

The financial markets are beginning to believe the Fed's rhetoric and the Risk Premium Charts have started  to turn modestly bullish.  With a little over one week to remaining before the Fed meets, the markets can wait it out, no need for a BUYING spree until there is a bit more clarity from Bernanke and company.  Investors will continue to hold out hope that the Fed will reduce interest rates once again and help boast the financial market and ailing housing market. 

• The Industrial Risk Premium ended at 6.05% versus 6.17%

• The Transportation declined to 6.67%  from 6.98%

• The Utility Risk Premiums declined to 5.32 % compared to 5.50%

The risk differential indices for the week ended December 7^th, 2007 have reversed the bearish trend that has been in place since early October - although this bullish reversal is not particularly strong.  n

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For November 30th's Comment Please Click Here

For November 23rd's Comment Please Click Here

For November 16th's Comment Please Click Here.

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