Tuesday September 6, 2005 - 11:29:39 GMT
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Black Swan Capital - www.blackswantrading.com
“Credit expansion cannot increase the supply of real goods. It merely brings about a rearrangement. It diverts capital investment away from the course prescribed by the state of economic wealth and market conditions.”
Ludwig von Mises
Is a skip by the Fed already priced into the dollar?
US $ index chart daily
What if the Fed CAN’T afford to skip? We believe this view from Ted Wieseman at Morgan Stanley 5 Sep ’05 sums up the situation quite well. We have emphasized the key points.
• Treasury yields plummeted the past week and the curve staged a massive reversal after initially flattening to new multi-year flat levels on Monday — a completely bizarre initial reaction to a supply shock that was quickly and hugely reversed through the rest of the week — as fixed income investors feared that devastation from Hurricane Katrina would tip the U.S. economy into recession or close to it, resulting in an imminent end to the Fed’s rate hiking cycle and a switch to rate cutting soon thereafter.
• But the interest rate market’s reaction — which stood in almost amazingly sharp contrast to a stock market that had its best week in almost two months — seemed to be a significant overreaction to the information we have at this point.
• So while it is not out of the question that the Fed could pause in its rate hiking cycle this month to wait for more information about the potential lasting economic ramifications of the catastrophe — as the futures market has rushed towards pricing in — we would put the odds of such a move at no more than 25%.
• And such a step could be very risky for a Fed that has in Chairman Greenspan’s words embraced a “risk management” approach to policy setting. Regardless of whether the Fed explained the move as most likely to be simply a brief pause within the tightening cycle in order to gather more information, extremely pessimistic fixed income investors would almost certainly ignore them and move to price in imminent rate cuts, collapsing yields along the curve in the process.
• If you think there’s a housing bubble now — and who could seriously deny it after the most recent OFHEO home price numbers released the past week showed a reacceleration in price gains in the latest quarter, resulting in by a wide margin the largest inflation adjusted gains over a three year period in the history of the data? — wait until the frenzy that would likely follow the yield collapse in response to a Fed pause being extrapolated by the market to an imminent rate cutting reversal.
• We certainly do not need a repeat of the disastrous 1998 rate cuts made in response to a short-lived and ultimately insignificant shock that inflated an overvalued stock market into a massive bubble and thereby led directly to the ensuing collapse and recession.
Black Swan Capital
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