Monday, April 28, 2008

Interest Rates: Get out your Polyester the 1970's are Back!

Well this week will be all about the Fed and what they do with the FF rate. I predict they will cut another .25 down to 2% and warn that this may be it because of inflation. They will then cross their fingers and pray that they can sit here for awhile and allow the banks to recover and hope going forward, higher inflation will be somewhat modest.

Speaking of inflation, there was an article in the Washington Post this weekend that says world food prices are up 80% since 2005. No wonder we are having food riots all over the world.

There was an interesting article in Bloomberg discussing interest rates and where we might be heading. From Bloomberg:

"Reserve Chairman Ben S. Bernanke may have to start talking and acting more like Paul Volcker if he wants to avoid being remembered as another Arthur Burns.

With oil and food prices surging, Volcker told the Economic Club of New York on April 9 that ``there are some resemblances between the present situation and the period in the early 1970s,'' when then-Fed Chairman Burns let an inflation psychology take hold. ``There was some fear of recession, the oil price went skyrocketing up, the dollar was very weak.''

It took Volcker's effort as Fed chief to push the overnight lending rate to 20 percent in 1980 and drive the economy into its deepest decline since the Depression to break the inflation he inherited. To avoid squandering the gains Volcker made, Bernanke may need to stop his all-out effort to prop up the weakening economy and start paying more attention to countering price pressures."

So what are the economists predicting going forward?

``It's most likely that they'll cut by a quarter point,'' says David Jones, author of four books on the central bank and chief executive officer of DMJ Advisors LLC in Denver. ``But I wouldn't be shocked if they don't cut rates at all.''

Fisher's Concern

``I'm concerned that we might be on a path of higher inflation than we would otherwise have had,'' Fisher said in a Fox Business Network interview aired April 22.
Since the start of the year, oil prices have risen 23 percent, while corn has climbed 27 percent and rice has jumped 76 percent.

``The economy in the '70s had a tremendous inflationary bias; the recession slowed inflation but didn't stop it,'' says Wyatt Wells, a professor at Auburn University and author of a biography of Burns.
``The lesson of the '70s is that, more than anything else, the Fed has to keep inflation expectations anchored,'' DMJ Advisors' Jones says. ``Bernanke is about to get hit right between the eyes with that reality"

My Take:

Expect another .25 because the market has priced it in. I think this it it though folks. Equities will be fighting the Fed going forward. Bernanke may end up having to do what Volker did at some point. Inflation is out of control. Can you imagine the fed funds rate at 20% instead of the 2.25% we have now?

Higher rates going forward are a must going forward in order to cool inflation. Expect this to do a number on housing. Just think you go to a mortgage boker and he quotes you a rate of 15%? You wouldn't be able to qualify to buy a closet at current prices.

Wall St. is going to have a fit as rates rise because it will not be good for stocks if the consumer gets crushed.

Sometimes you just need to take your medicine. We are already heading back to the 1970's. If Bernanke doesn't watch his step it could be worse. I wonder if there are any disco songs that I can download on I-Tunes. The seventies are back.

Quick newswire alert from DowJones on the financials:

JP Morgan says sell the financial rally:

Morgan Stanley Says Sell Financials' Rally, Risk Not Over Yet0 minutes ago - Dow Jones NewsBy Ed Welsch Of DOW JONES NEWSWIRES Sell the rally in financial stocks, analysts at Morgan Stanley told clients Monday, saying more capital raising, dividend cuts and deleveraging are coming across the sector. Financial stocks rose in last week's trading as momentum investors rotated out of securities seen as safer, such as commodities and U.S. Treasury securities, and into investments that had been shunned, like corporate bonds and financial stocks. Financial stocks in the Standard & Poor's 500 index are up more than 15% from their lows on the March 17 bailout of Bear Stearns Cos. (BSC). The tentative movement back into risker investments shows that some investors are willing to test the idea that things are looking up for battered financial companies. But Morgan Stanley analysts Betsy Graseck, Cheryl Pate and Justin Kwong aren't convinced. They believe the difficulties in the credit markets are only in their "3rd inning," and that the situation will be worse than the recessionary environment of 1990 and 1991. "We think it's a mistake to chase this rally," they wrote. "The risk is much greater that credit deterioration will accelerate and banks will raise more dilutive equity and cut dividends [more] than expected."

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