Market Update/Interest Rate Cuts are Over

Alright guys and gals lets get right to it.

The market reversal intensified today as oil soared over $134/barrel, and the Fed minutes were very hawkish on interest rates.

I don't know how else to put this. The market is realizing that with soaring energy costs, the Fed simply has lost all of its power on the markets. The basis of the current rally from March is the Fed will save anyone thats in trouble. Inflation has completly taken that chip off the table.

George Soros explained it best today. Soros from Reuters:

"LONDON, May 21 (Reuters) - Billionaire hedge fund manager George Soros said on Wednesday the current rebound in stock markets is only a bear market rally because monetary authorities are unlikely to be able to handle the credit crisis.

Soros told a seminar at the London School of Economics, "The prevailing market opinion is that this crisis is like previous ones. ... Markets have been rallying on that. But I think it's actually just a bear market rally based on a false conception the authorities can handle all these crises.
"This time the ability of the authorities to handle the crisis is constrained -- they'll not be able to avoid a recession," he said

"Certainly the idea that the economy is going to recover (at the end of this year) is totally unrealistic," he said."


My take:

Soros nailed it in a few sentences. I have been warning that this recession will be different then the baby recessions we saw in '91/2001 because its a consumer led recession and inflation is raging!

Inflation completely takes the Fed out of the game. Their hands are totally tied. The rate cutting has forced inflation to rise much more rapidly than anticipated, and there isn't a darn thing they can do about it. That's right folks, the Fed is now powerless.

This is why you saw the financials get creamed today. No more rate cut gifts to Wall St. There has been talk that the Fed is actually beginning to pull liquidity from the system in a very quiet manner by reducing liquidity injection amounts.

Why would they be doing this? To try to put a cap on inflation. Inflation has the potential to stop an economy in its tracks, and the Fed simply can't risk this in order to save some financial institutions.

So what does this mean? The market is now on its own, and companies like Bear Stearns that should have failed will not be saved by the Fed going forward.

Stay away from financials in this inflation environment!


The Fed Minutes

So how hawkish was the Fed in their minutes report? Well they basically admitted that we are lucky we got our rate cut in April. Most of the Fed officials thought cutting in April was a bad idea. Gee you think so as oil now passes $134/barrel?..Duh!

Here are some comments from the Fed minutes today on Bloomberg:

"May 21 (Bloomberg) -- Most Federal Reserve officials viewed the decision to cut the benchmark interest rate as ``a close call'' in April, signaling they may hold off from further reductions.

``The risks to growth were now thought to be more closely balanced by the risks to inflation,'' minutes of the April 29-30 Federal Open Market Committee meeting, released in Washington today, said. Several policy makers judged ``it was unlikely to be appropriate'' to lower rates further unless data indicated a ``significant weakening'' in the outlook.

``Although downside risks to growth remained, members were also concerned about the upside risks to the inflation outlook, given the continued increases in oil and commodity prices and that fact that some indicators suggested that inflation expectations had risen in recent months,'' the minutes said.

`Calibrated' Stance

Fed Vice Chairman Donald Kohn said yesterday that ``monetary policy appears to be appropriately calibrated for now to promote both rising employment and moderating inflation of the medium term.'' He also said the recovery in growth into next year may be ``relatively moderate'' as it will take time for investors to regain confidence and for housing demand to rise.

Stocks tumbled after the report stoked speculation Chairman Ben S. Bernanke and his colleagues are finished lowering borrowing costs as the threat of inflation rises.

`A Crawl'

``Growth in consumer spending appeared to have slowed to a crawl in recent months and consumer sentiment had fallen sharply,'' the minutes aid. ``The outlook for business spending remained decidedly downbeat.''


Final take:

Well I guess since they now see the consumer "crawling" like a two year old, they realized maybe we better stop slashing rates and killing the dollar.

The stock market is extremely vulnerable here. If rates start to rise you will see destruction in the financial markets and housing. If interest rates continue to drop, the consumer gets strangled by inflation. The Fed can't win in this scenario just like it couldn't in the 70's. All they can do is choose the lesser of two evils.

Which way will the Fed go?

When push comes to shove, the Fed will let the market potentially tumble in order to protect the consumer and itself. Remember, the Fed is almost broke from trying to save Wall St. They have spent over 1/2 of the $800 billion they have in reserves, and it hasn't done anything other than save the pigmen from going under.

Now that inflation is soaring and the average American is in jeopardy due to inflation, expect the Fed to turn their heads and hope for the best as the blood hits the streets in the markets. They simply have no other choice.

The bear market rally is over.

Long term, this will be healthy as we wring out the losses and get back to a more affordable standard of living.