Desperate Measures

The Fed’s action to either raise or lower rates has become a major focal point for the markets in recent years. It seems that the vast majority of the public believes that the Fed is actually controlling interest rates and as a result that they are controlling the credit and equity markets. For a week before the Fed meeting it seems that the entire global markets focus on “what the Fed is going to do.” Will they cut a quarter, will they cut a half or will they not cut at all? Then, after the meeting the talking heads and analysts sit around and try to analyze the meaning of their “Fed Speak.” This is a joke. I am about to show you the proof that the Fed follows the short-term credit market and that in reality they do not lead. The data simply does not support this widely held belief. I realize that this may come as a shock to you, but reality is what it is. The data speaks for itself.

In the charts below I have plotted the Discount Rate in the upper window and the 3-month T-bill rate is printed in the lower window along with my Trend Indicator. I realize that you cannot tell it from this chart, given the time period and the size of the charts, but the fact is that the 3-month T-bill rate moves first and the Fed simply follows. Given that this is a well documented fact, with a 60 year history, I am simply amazed and amused by the fact that so many people put so much emphasis on what the Fed does in regard to interest rates. Fact is, the Fed and their media propaganda machine together have conditioned the vast majority of the public that they somehow control rates and as a result control the equity markets. If you go to www.cyclesman.info/Fedfollows.htm I have posted more detailed charts. All you have to do is start at the beginning and move forward in time and you will clearly see that the Fed follows the short-term credit market.

Now that this fact has been established I want to talk about another myth. I think you will also agree that the perception is that the Fed saved the market back in 2001 and 2002 with their aggressive rate cuts. Well, we just established the fact that the Fed follows 3-month T-bill rates. Fact is, the 3-month T-bill rate fell from 6.22% in November 2000 to 5.70% in December 2000. In doing so my Fed model confirmed that we had moved into a rate cutting cycle. It was then, at the January 2001 Federal reserve meeting that the Fed made the first cut of the Discount Rate taking it from 7.50% to 7.25%. Both the stock market and the 3-month T-bill rate continued to fall and the Fed continued to more aggressively cut rates to

keep up with the falling T-bill rate. Now, look at the chart below.

In the upper window of this chart I have again plotted the Discount Rate. In the lower window I have plotted the S&P 500. As you can see, the rate cuts did nothing to stop the decline. From the time the rate cuts began in January 2001 the S&P 500 fell from 1,283 all the way down to its final low at 768. This was a 40% slide in the S&P in spite of the rate cuts. Fact is, some of these rate cuts did absolutely nothing to hold the market up and in many cases they made multiple cuts and still the market fell. This was particularly true from early 2001 into the fall of 2001. There was a bounce after the 911 bottom, but even the rate cuts following 911 did not prevent the continued decline into the 4-year cycle low in 2002. I don’t have the data during the 1920’s and 30’s, but I do know that the Fed also cut rates and it did nothing to save the market then either.

Now look at the current period. The Discount rate has fallen from 6.25% in August 2007 to 1.25%. All the while the S&P 500 has declined by some 46%. Again, the rate cuts are not working and I reported in 2007 when this rate cutting cycle began that it wouldn’t work. The fact of the matter is, we have entered into a bear market in equities and cutting rates has not mattered in the past and it has not and will not save the markets this time either.

Now, on another note I want to point out just how desperate the rate cut we saw on October 29, 2008 was. In looking back at my database I found that since 1943 the Fed has NEVER cut rates when the spread between the Discount rate and my blended end of week 3-month T-bill rate was less than 1.08%. With that being a weekly rate I obviously have no way to know what that blended rate was on Wednesday, but I can tell you that as of last Friday it was at 1.25% and with the Discount rate at 1.75% this put the spread at a mere .50%. As of Tuesday's close I showed the 3-month T-bill rate at .77% which puts the spread at .98%. So, I can tell you that it is a matter of record that in the past 65 years they have NEVER cut with this spread less than 1.08%. Therefore, I can also tell you that Wednesday’s rate cut was an unprecedented event. I feel that the only reason the Fed made this cut was because the market was expecting that cut and they were scared of the consequences if they disappointed the market. That being said, if the market has already fallen well over 40% with the cut from 6.25% to 1.75%, do you really think that additional cuts at this point will matter?

Sure, there will be bounces along the way, but we have entered a secular bear market that was led by the largest credit bubble in history. This is not something that can be fixed by cutting rates and throwing more credit at the system. The facts clearly show that the Fed follows the short-term credit markets and that the October 29, 2008 cut was a desperate and unprecedented event. The continued bailouts, stimulus packages and rate cuts are all just desperate attempts by the braniacs that got us into this mess in the first place. Don’t buy the propaganda when and if a bounce begins. This bear market is not over. You have been warned!

November 1, 2008

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