special reports

Even the market’s dour forecast for Tuesday’s FOMC rate decision proved too optimistic. The Fed would cut the US benchmark lending rate 75 basis points to a record low; but technically the central bank is actually targeting a rate between 0.00 and 0.25 percent. In essence this is a zero interest rate policy (ZIRP), just without the stigma that accompanies this unpopular policy stance. This officially marks the end of the line for standard monetary policy from the central bank (though they could officially drop the range). However, both the economy and markets are still reeling; and Chairman Ben Bernanke and his fellow policy members will have to devise alternatives to changes to the benchmark lending rate to bring an end to the worst recession and financial crisis in decades. The bank has been ensuring mortgage-backed securities and agency debt for some time; and buying treasuries evokes comparisons to Japan’s lack of success over the past decade. The market intently waits for alternatives.

Market conditions have been unsettled by the Fed’s historic rate shift. Initially, the additional rate cut spurred a false sense of security that rallied capital markets. However, the reality is quickly sinking into the market. Policy officials have run out of rope with traditional monetary policy and the risks are as great as ever. The government has skirted the potential collapse of the US auto industry and other sectors are likely queuing up for the same. Not only will bankruptcies here further plunge the economy into recession; but it will spark a fire sale in capital assets (as well as shares). More concerning, defaults on loans and obligations could trigger another seizer in credit markets.

The bottom is not yet in sight; and the Fed has run out of options in its traditional policy spectrum. Growth is the primary concern for policy officials at this point, and they will have to act with unique fixes aimed specifically at the American consumer and business to put the economy on solid ground. As Chairman Bernanke and his fellow policy members try to come up with a creative solution going forward, the holiday season promises tip the world’s largest economy into a steeper nose dive. After more than half a million jobs were lost last month - and considering  spending and confidence are already nearing record lows – it looks like it will be an anemic holiday season.

Capital markets received an initial boost after the Fed announced it was cutting rates by a greater than expected 75 basis points. However, investors have realized that this additional step will do little to ultimately turn the economy from its worst recession in decades while simultaneously turning investor sentiment back into positive territory. In fact, this move merely shows the lack of options left to the policy group charged with stabilizing the economy and ensuring credit is available to the market. Looking at the true fundamentals behind the market, the Fed is far from a solution to either of these problems. The economic slump is just beginning to hit its stride with consumer spending failing and business activity falling on the receding demand. Far more ominous though is the potential for many of the economy’s most important industries to teeter into bankruptcy. The auto group is still in limbo.  

Markets have actually shown considerable strength over the past few months considering the failing outlook for the economy and markets. This more likely a reflection of year-end position squaring than a genuine rebound in the markets; but it is congestion nonetheless. Equities are still dealing with the uncertain future of GM, Ford and the other major US auto manufacturers. Not only are theirs shares weighing heavy on investor sentiment; but it is also having a direct impact on the availability of credit (or lack thereof). Commodities are purely a reflection of the lack of activity in the global economy.

Risk is still near record highs – a dangerous position to be in considering the year is near an end and liquidity is expected to drain for the year-end holiday period. Realistically, major fundamental themes like a credit crisis and economic slump will not resolve themselves over an extended holiday break. Nonetheless, a look to volatility in the VIX has shown that fear has recently pulled back, as it has in the currency market. However, when the markets are back up to full capacity, traders will be reminded that major sections of the US economy are on the verge of collapse and the Fed is out of options to help.