“FED UP? NO, NOT YET!”
Fed Comment, 08/21/2007
The highly interest rate sensitive energy sector received
some relief from the Fed in the form of a of 50 basis point cut in
interest rates, lowering the discount to 5.75% from 6.25% a move
targeted at lowering the borrowing cost for Banks. The Banking sector
has is being aided by the Fed’s response by continuing to
supply the necessary cash to Banks in order to meet the
short-term demand for funds.
The Fed did not, however, alter the more important Federal
Funds rate target of 5.25%. Nevertheless, a change in the discount rate
is good news for “the market.” Turbulence in the credit markets is not
good news for the capital intensive energy sector – and has placed
downward pressure on the energy sector for several months.
Our impression is that the Fed has been playing fast and
lose since the beginning of this year, suggesting that an increase in
rates was not imminent but, indeed, possible. A change in the Fed Funds
rate – or the “target” – would suggest a shift in long-term policy –
which should have a lasting effect on the market as opposed to the
knee-jerk reaction to the discount rate cut.
What Now My Dow?
The energy industry is not immune from the overall melt-down
in the capital markets, which is being driven by liquidity needs rather
than value, resulting in a free fall across all sectors. The
Dow Jones Utility Index has been in a slow state of decline as concerns
over the cost of credit persist. The Dow Jones Utility Index is still
off about 14% this year, after reaching a high of 538.31 in May. No
sustainable rebound in the energy sector is probable until the Fed
signals that it is no longer biased towards increasing rates.
With the Presidential
Elections 15 Months Away, Why Waste a Good Rate Cut?
We feel the federal
government has been teetering with the Fed Funds rate for several months
and unless and absent a permanent change in this stance, it is difficult
to envision a sustainable rally in any segment of the market. Moreover,
from a political vantage point, why waste a good “rate cut” (notably
the Fed Funds rate) when the Presidential elections are 15 months off,?
For political reasons, the Republicans might benefit by a build up in
economic pressure – at which point the Fed strategically steps in with a
very significant reduction in its long-term interest rate policy –
thereby halting the slaughter in the capital markets with a “major”
policy adjustment.
Energy legislation pending
before Congress is likely to be embroiled in 2008 politics and revised
legislation is regarded as a critical impetus for the funding of Green
Energy companies. Energy companies, in particular, remain vulnerable to
interest rates and therefore as long as the market suffers from interest
rate and energy policy anxiety, there is no incentive for energy stocks
to advance.
Could The Fed be
Posturing?
We
hypothesize, however, that the timing of any change in interest rate
policy may be pegged to the 2008 elections. Action by the Fed affecting
long-term rates could be withheld for political purposes so that as, if
and when the Fed intervenes in a meaningful way, Republican Candidates
would enjoy the maximum political leverage (i.e. as concerns about the
economy become the central political issue) – perhaps even deflecting
from controversy surrounding the war (
...the one that ended 4 – years ago). Intervention is best
delivered at a time when polls really start to heat up. It may be
politically premature for the Fed to aid the markets with sustainable
measures since the advantageous impact on the market is likely to be
forgotten by the primaries and the time voters go to the polls in
November 2008.
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