Fed Force-feeds Funds into the System

Top O the Morning… And Happy St. Patrick’s day to everyone. Chuck headed off to what he commonly refers to as ‘Heaven on Earth’ as he went back down to Florida to watch spring training. As Chuck left on Friday, the currency markets had settled down as London had closed up. But later in the day, news of an emergency Fed bail out of Bear Stearns sent the dollar down even further.

Readers will likely remember that Bear Stearns was the firm that brought to light the whole subprime mess last July with the collapse of two of its hedge funds, which invested in securities linked to subprime mortgages. Over the weekend Bear Stearns was sold to JP Morgan Chase & Co. for just $2 per share, well below the $84 book value of the company. In fact, the total sale price is only one quarter of the value of the securities firm’s headquarters building in midtown Manhattan. Can you say fire sale?? This sale illustrates just how bad things are on Wall Street, and how afraid everyone is of all of the ‘nasty stuff’ hidden in these firms’ balance sheets.

Before the sale was announced, the Fed stepped in and provided emergency funding to Bear Stearns through JP Morgan in order to avoid a collapse. But the Fed didn’t stop there. Minutes after the sale of Bear was announced, the Fed cut the so-called discount rate by a quarter of a percentage point to 3.25%. In my opinion, this is what the Fed should have done months ago, as the discount rate cut will have a much greater impact on the credit markets than the big Fed Funds cuts enacted over the last few meetings.

In its first weekend-emergency action in almost three decades, the Fed also said it would lend to the 20 firms that buy Treasury securities directly from it. Bernanke is trying to force feed funds into the banking system to help loosen up the credit markets. These unprecedented moves are further proof that the Fed is still reactive instead of proactive. There is little doubt that the Fed will announce a further cut of the Fed Funds rate tomorrow. The markets are expecting a cut of 50 bps, but some still feel 75 bps are possible. I think it is obvious that the Federal Reserve is running scared, and ‘Helicopter Ben’ is doing just what many predicted he would by throwing as much money into the system as possible.

But all of these rate cuts and cash infusions have got to be inflationary right? Not according to the ‘official numbers’ that were released on Friday. U.S. consumer price inflation, as reported by the government, actually fell during the month of February!! Does anyone really believe prices for consumers are falling? I won’t even justify these numbers by reprinting them here, as they are absolute fantasy! But these numbers did give the green light for the Fed to continue to cut rates, which they immediately did over the weekend.

These aggressive moves by the Fed have all but sealed the fate of the U.S. dollar. Currency traders have continued their assault on the greenback, and there is currently no rescue in sight. I don’t think even Hank Paulson can seriously talk about a strong dollar policy anymore. They have obviously thrown inflation concerns and concerns about the weakening currency out the window and are just trying to keep the U.S. economy from falling off the precipice on which we have been perched. Unfortunately I think we have already fallen off, and it looks like the currency traders agree.

The Europeans also announced consumer price inflation, and their report showed price increases accelerated to 3.3% in February, the highest in 14 years according to the European Union’s statistics office. That is faster than expected, and a much more realistic assessment of current conditions. Labor cost growth quickened in the fourth quarter to the highest since 2006. ECB President Jean-Claude Trichet last week quashed speculation of a rate reduction by stressing the bank’s commitment to price stability even as economic growth cools. The ECB has not wavered from their primary focus, and the euro (EUR) will continue to benefit from their strong guidance. The euro will continue to be seen as the world’s ‘new’ reserve currency, and investors and countries will likely continue to diversify out of their dollar holdings into the euro.

But two other currencies were the biggest movers in Asian and European trading. The Swiss franc (CHF) rose beyond parity against the dollar, and the Japanese yen (JPY) traded all the way to 96 overnight. The credit crisis in the United States led investors to sell the higher yielding emerging market assets and repay loans in both Japan and Switzerland (carry trade reversal). The Swiss franc is still seen as a safe haven for currency investors and will likely continue to strengthen as market volatility picks up. The franc was also supported by speculation that the Swiss National Bank will hold rates steady in an effort to combat rising inflation.

With the United States hell bent on lowering interest rates, even the low yields on Swiss francs and Japanese yen are beginning to look attractive to investors. The rise of the Japanese yen has largely been a story of the reversal of carry trades, as the economic fundamentals and political stalemate don’t really justify the recent moves. The political stalemate has allowed the currency to move up unchecked, with the BOJ unable to intervene in the markets to slow the yen’s quick rise. Without intervention, the reversal of all of the short positions will likely continue to push the yen higher.

With the whole market turmoil and credit crisis, investors have turned to precious metals as an inflationary hedge. Gold shot over $1,000 per ounce and traded as high as $1,032 in European trading this morning. Silver also benefited from inflationary concerns and moved up to trade over $21.35 in London. Inflation continues to be a concern and precious metals are a popular choice for investors. Our MetalSelect pooled accounts are an excellent way for investors to take advantage of the precious metal markets and are our lowest cost options for direct purchases of gold or silver.

Currencies today: A$ .9221, kiwi .8035, C$ 1.01, euro 1.5774, sterling 2.005, Swiss 1.0185, ISK 74.99, rand 8.1572, krone 5.1060, SEK 6.0061, forint 165.65, zloty 2.2554, koruna 15.9125, yen 96.50, baht 31.39, sing 1.3867, HKD 7.7677, INR 40.81, China 7.0831, pesos 10.8088, BRL 1.7130, dollar index 71.65, Oil $110.69, Silver $21.02, and Gold… $1023.73

That’s it for today… I’ll close this morning with a Happy St. Patrick’s Day wish to my favorite Irishman, Dad. It has been a pretty rough year for my father, as we had to move him into a home due to the ongoing effects of Parkinson’s disease and the accompanying dementia. But we were able to spend a great day with him yesterday as we celebrated St. Patrick’s Day at my sister’s home. My father is a first generation American, so St. Patrick’s Day is a very big deal in the Gaffney family. My grandfather left his home in County Roscommon at the young age of 11 and rode his bike across Ireland to Dublin where he went to work at the Guinness factory in order to earn enough money to come to America. After a few years, he sailed away from England on a sister ship to the Titanic bound for New York. As the luck of the Irish would have it, a young girl who would eventually become my grandmother was also on her way to America. Both ended up coming to St. Louis where they settled down and raised six boys and a girl. So each St. Patrick’s Day I raise a glass of Guinness, who financed my Grandpa’s trip to this great land of opportunity. Happy St. Patrick’s Day to all of you!

Chris Gaffney
March 17, 2008