The Fed Heads Just Don't Get It!

Good day… And a Wonderful Wednesday to you! As each day goes by, I see stocks wilting in the August heat. Consumer confidence did fall, and that didn’t help stocks.

The reason I started off today’s letter talking about stocks is that I think they tie into the theme I’ve talked about this week, and that is whether or not the markets are willing to take on risk. If stocks are getting sold, I believe that’s an indication that risk aversion is back on the table, which leads to what I believe is a mass exodus from the carry trade!

But, that’s what happened yesterday and last night. Who knows what the markets have in store for us today, or tomorrow, or the next day?

Yesterday though, we had classic carry trade unwinding signs… Japanese yen (JPY) and Swiss francs (CHF) were strong, while kiwi (NZD), and krona (SEK) saw weakness.

Here’s a reason for the move to risk aversion… Subprime jitters returned to the markets as it was reported that state street is heavily exposed to asset-backed conduits. Then we had Merrill downgrading the stocks of Bear Stearns, Lehman, and Citigroup.

After the U.S. close, S&P reported that Cheyenne Capital Mgmt. Ltd., a $20 billion commercial paper program, might liquidate due to losses. Uh-Oh… This is looking like it’s all going to unravel soon.

I just don’t think the Fed Heads realize that their discount rate cut didn’t really do anything to alleviate the problems from the subprime mess, and all the derivatives floating around the world.

The S&P/CaseShiller house prices data that I mentioned yesterday, fell more than expected (-3.5% versus -3.3% expected). This is an index for 20 metropolitan areas, which doesn’t necessarily mean that house prices in your neck of the woods have fallen like that… But, since it does represent 20 metro areas, this should be a good representation of what’s going on.

I’ve talked till I was blue in the face about this… And how falling house prices were going to really play heck with those ARM’s that are coming due and homeowners have taken all the equity out of their houses, as they used them like ATM’s. To me, the people that have fallen into that trap are in for some real shocks, and finding out that their home is worth what they thought it was is just one of them!

The August 7 Fed meeting (FOMC) were printed yesterday and here are a couple of things I found interesting.

1. The minutes indicated that the weakness in housing could continue longer than expected.

– Really? You bunch of knuckleheads… This has been as evident as a man with a hatchet stuck in his forehead!

2.  Despite the concern about financial market volatility and the weakness in housing, the central bank remained guardedly optimistic about growth with support expected from healthy job gains.

– Really? What planet are you counting the healthy jobs on? Have you not seen the rot on the employment vine, and all the layoffs being announced? And what about all the jobs associated with housing that are going to go by the wayside?

I’ll stop there… The Fed Heads are still attempting to tell us “feel good stories” to give us a warm and fuzzy.

The euro (EUR) saw some weakness yesterday as I believe the European Central Bank (ECB) is feeling a change of heart toward their previously ordained rate hike at the September 6 meeting. I’ve just heard some dovish tones coming from the ECB and that’s not like them! Inflation is, for now, under their 2% target, at 1.8%, but money supply continues to run at a very strong clip. If I were Claude Trichet I would go ahead and hike rates again. But that’s the inflation fighter in me!

OK… I don’t know if I’ve ever quoted Jim Sinclair before, but I follow his articles from time to time and I am in agreement with his thoughts, especially on this one, which is why I’ve put it in the Pfennig!

Jim Sinclair, a well-respected investment analyst, had the following to say about the current subprime/liquidity mess in his latest newsletter. This is just a snippet because the actual full piece is too long for the Pfennig. So here goes…

“If it was simple mortgages it isn’t apparent because as bad as the mortgage market is they have not all failed simultaneously as if all sub prime mortgage holders have been foreclosed on at once. That alone should give you a hint that the problem is not the advertised, but much larger.

“The Fed altering their banking regulations has to give you a hint that the problem is not the advertised problem, BUT MUCH LARGER.

“The financial difficulty going global has to give you a hint that the problem is not the advertised problem, BUT MUCH LARGER.

“When you see bank after bank needing liquidity in substantial amounts, this has to give you a hint that the problem is not the advertised problem, BUT MUCH LARGER.

“The hope for every central bank is that the real problem can be kept from public view. The truth is the public, even professionals in Wall Street, have no clue what the problem is. They know it has something to do with derivatives, but none realize it is a more than $20 trillion dollar mountain of unfunded, unregulated paper that has just been discovered to not have a market and therefore any real value.

“This is why I have suggested you plan for the worst and hope for the best. Taking cautionary action before a problem occurs only requires some of your time. If you wait and try to clean up the mess after a problem happens usually there is no action that can be taken.

“When the U.S. dollar realizes the seriousness of this situation, be that now or sometime soon, the bottom will drop out.

“The dominos are falling and only a few really know why. Sometimes I wish I did not understand derivatives. I would certainly be held in better light.”

OK… Jim is like me in that he sees this all pointing to dollar weakness, which could be the reason the Fed seems to have this “ho-hum” attitude in the meeting minutes. They certainly don’t want panic in the markets. And they don’t want our biggest creditor to see there are cracks in the foundation.

That’s right! It’s like your banker comes to your house to have you sign papers for a loan on your house. You don’t want him to see the shutters hanging by a nail, windows broken, gutters hanging off the roof, etc. And, the U.S. doesn’t want China to see our financial system with problems either!

Anyway… The currency market here in the United States is being run by junior traders this week, as the Big Boys have headed to the Hamptons for the last holiday of summer. The junior traders have been left strict instructions to not take on any new positions So… That leaves trading here in the United States thin – thin as Olive Oyl! (Now that’s thin!)

The thin markets simply mean that any strong direction in the currencies is going to have to come from the European and Asian markets. I doubt they will want to direct currency traffic without their U.S. partners, so… No wild swings are expected. However, sometimes things get a little hairy for the junior people and we see strange things in thin markets… Those are rare however.

Currencies today: A$ .8195, kiwi .7010, C$ .9440, euro 1.3630, sterling 2.0125, Swiss .8325, ISK 64.18, rand 7.2350, krone 5.8440, SEK 6.8950, forint 188.88, zloty 2.8190, koruna 20.29, yen 115, baht 32.65, sing 1.5240, HKD 7.80, INR 41.13, China 7.5490, pesos 11.10, dollar index 80.70, Silver $11.97, and Gold… $674.70

That’s it for today… Good news for my little buddy, Alex; the school just called and classes are cancelled for today. Get this… The air conditioning is out! Oh the humanity! No air conditioning in school! HAHAHAHAHA! Had a visit from Delaney Grace yesterday (my darling granddaughter) and I was on a conference call to the office. She started fussing, and I told everyone…Hey! That’s Delaney Grace, but they people in the office didn’t hear me, they just all talked over me like they had something important to talk about! HAHAHAHAHA! I’ve been dozing off a lot during the day; I assume it’s from the medicine. Sure can’t go back to work if I’m going to fall asleep at the desk! UGH! Oh well, I carry on… Have a Wonderful Wednesday!

Chuck Butler
August 29, 2007