watch what the fed watches

Is confidence in the US dollar and economy perking up? With the greenback marking significant advances against the euro and Japanese yen over the past few days, it seems that market participants are growing more encouraged that policy efforts made in the United States may be putting the world’s largest economy ahead of the recession curve and on track to pace the eventual global rebound. Initially, Treasury Secretary Timothy Geithner’s announced expansion of the Financial Relief Program and the passing of the $787 billion financial stimulus package roused little confidence from skeptical traders and consumers. However, with President Obama announcing plans to put $275 billion towards mortgage adjustments and major banks agreeing to defer foreclosure proceedings, there are signs that the public and private sectors are starting to work together to come up with a real solution. However, the outlook is still daunting as the economic recession and financial crisis are global issues.

Financial market conditions have deteriorated somewhat over the past week – complicating the policy makers’ efforts to open credit to consumers. Interest rate cuts, liquidity injections and government bailouts have so far been directed towards stabilizing the flow of credit in the market. The sharp decline in Libor and Treasury rates is still the most prominent sign that the effort is paying off. However, there is still a major disconnect between credit at the institutional level and the consumer level. And, while the government is now dedicating funds to this ultimate driver of economic growth, a rebound at the banking level certainly hampers the policies’ effectiveness.

Policy makers may be able to see the light at the end of the tunnel; but consumers and investors are more concerned about the here and now. And, considering the forecasts for this year’s economic numbers, the pain will grow to be much worse before it ever starts to improve. In today’s FOMC minutes, the central bank offered its long-term projections on growth, employment and inflation. For 2009, the target range for expansion was lowered -0.2 to 1.1 percent down to -1.3 to -0.5 percent. Even these numbers likely reflect a rebound in the later part of the year; but the intensity of the country’s slump will still act as a significant driver for investor sentiment for weeks.

Investors are clearly hesitant to express any tangible forms of confidence when it comes to their trading habits. Over the past week, we have seen the benchmark equity indexes push closer to the multi-year lows set back in October/November, commodities have sustained their downward projection and interest in the short-end of the Treasury curve rise as capital seeks a safe haven. All of this has transpired despite a clear increase in policy makers’ efforts to support the economy and stabilize credit. These long-term efforts will no doubt have their impact; but what will the damage be before positive growth returns? As it is, imminent bankruptcies have spread beyond the financial sector and consumer spending may see a permanent change after this cycle bottoms. A quick solution to a long-term problem will ultimately stifle a genuine recovery and could even lead the market directly into its next crisis.

Capital markets have threatened to overrun new lows this week, suggesting investors are pessimistic until proven otherwise. This means that promising fundamentals and news will be absorbed and graded against what may be considered a long-term bear market. For stocks, the benchmark Dow Jones Industrial Average dropped to an intraday low below 7,500 in today’s session, curbing its declines just before making an official test of the Nov 21st, six-year low. From a macro standpoint though, the drop in the CRB commodity index to its lowest level since June of 2002 is more disturbing as prices reflect expected production activity and therefore growth.

With benchmark market indicators pushing towards unfavorable levels, it follows that risk trends have picked back up. Specifically, should equities push to new record lows, it would indicate that the markets are in a long-term bear trend – as opposed to recovering from fears over structural fears for credit and investment that dominated investors concerns back in October. However, most asset classes have not forged new lows; and therefore risk premiums have not fully inflated. However, the VIX, junk bond spread and default swaps are all ticking up from their already, historically high levels. At this point, a plunge in sentiment would undercut the US government’s considerable efforts-.