8/5/08 (FED DAY - a coup d’état?)

Traders,

First let me clear up yesterday’s story about First Priority (I got a lot of emails and even a few phone calls). First, I do NOT bank there. I happen to know the manager/owner of the building and offered assistance since I was close to the building, until he could get there – as the FDIC has some questions and issues with A/C and building access. Hope that clears the questions up.

Well – yesterday we saw the indices get to some support areas (1800 NDX, 700 RUT, 11250 INDU) – and now we are seeing the futures rally off these points in the pre-market session. Part of the rally is a big help from OIL, which broke down below the $120 line for the first time. But today has something else in store – yeah – It’s FED DAY! Don’t expect a move (up or down) – but expect lot’s of over analyzing of the language – all the talking heads are getting ready to interpret what Ben is actually saying.

_____________________________________________
FED DAY- a coup d’état ?


Previously – it was all about whether he would raise or lower rates – those days are done for now. He has cut hard and fast in early 08, and has now pretty much run out of room for any more cuts. Yeah – he would like to cut more (so too would the Financial institutions enjoy another big cut) – however he is now in between a rock and a hard place. Inflation, whether you want to measure it by the CPI (over 4%) or use pre-1990 CPI calculations (8+%) – we are seeing it on Main Street. Ask anyone – and energy bills, food prices, gas prices, everything is higher. So the spin that the “Core” is showing little to no signs of inflation – well – I don’t think that talk will fly anymore.

The FED’s tool box is pretty sparse – with only the ability to raise and lower the Target and Discount rates. However, the Target has really taken a back seat because all the big action is at the Discount Window. I had posted a chart of the Discount Window borrowing a couple of preview ago – and it was fairly shocking. Throughout the history lending by the FED – we have NEVER seen close to the kind of money that is being lent. We are up in the 200 billion range, when historically 100 million was a lot. Why? Well – I think it’s a combination of the reserves that are lent via the Target being tapped out and what money financial institutions DO have is needed at home rather than being lent out. The proof of that is how tight money (lending) has become. We have seen bond auctions across the board fail, corporate bond rates go higher, and now the Fed is even having problems raising money - as there are fewer market makers in the Treasury Market (which typically took down 70% of the auction – has now fallen to 40%).

The FED has also expanded its job and responsibilities, it has aligned its self with the Treasury and working with them on a bailout of Freddie and Fannie (two GSE’s that now have access to the Discount Window). It is taking an active role in negotiating bank takeovers (unders). It is also expanded its role beyond Fed members – but to other financial institutions as to lending money, extended access to the window (from Sept. to Jan.) and extended the borrowing time (30 days to 84 days).

So – while he probably will not raise or lower rates (since raising rates will put lenders in a deeper hole and lowering rates will increase inflation) – he does have lots to talk about. Ben “Superhero” Bernanke is on a crusade to save everyone and anyone from failing – the Discount Window is open, he will negotiate take-unders (and insure them), and also will NOT let the GSEs fail. Further pressure has been put on the SEC to single out these Financial firms and protect stock price (by issuing limited shortening ability).

No doubt the role is expanding for better or for worse. The problem is that single tool (ability to adjust rates) is not enough – and the Fed’s powers are expanding.

There are grumblings over at the FED as three of the Fed Open Market Committee may dissent for the first time since 1992. Policy makers are getting very concerned about ramping inflation (the fastest in 17 years – and that is using the post 1990 model – I think they would be in for a real shocker if they used the pre-1990 model). These three Fed members have been calling for a rate INCREASE. So that means – if he does NOT raise rates – he is going to need to talk REALLY TOUGH – expect more “We are STRONG dollar people” spin.

This leaves us with a possible surprise – while a low probability – he could pull off the coup d’état by lowering (or keeping the same) the Discount Rate and raising the Target Rate – thus trying to appease two camps – fighting inflation and continuing to service more debt. If the Discount Rate gets to even, or god forbid – below the Target – there will be no incentive for banks to borrow from each other – if they can just go to the Fed and get money cheaper and for longer borrowing periods.

No doubt these are historical times – it is now up to Ben and what he has to say. Of course we will see every “Talking Head” read way to deep into the words – as if they are trying to decipher the Rosetta Stone.

__________________________________________________
Inflations mean economies weaken

The loss in buying power, jobless rates, and inflation – all of which I am sure Ben will be talking at great lengths about – is also seeing a weakening in prices. We have seen oil come down from the lofty 140s to 120 (even below that today) and also several other commodity futures are coming off. However, after doing a little reading up on consumption rates – while the US is the leading consumer and is seeing weakness – the global stage is still seeing growth. The question is when does that inversion happen when we (the US) are no longer the center of the consumer world and another (or groups of) nation/s take that crown? Brazil, Russia, India, and China (AKA the BRIC) are charging full steam – their consumption across the board on commodities are up, however not enough to supplant the US as King of the Consumers.

So for now – the world watches the slow down on consumption in the US and we see prices in commodities come off. There is a bottom to these prices and I think we may find it sooner rather than later. Additionally – the Summer is coming to a close and the Fall approaches – and with that energy prices increase (heating oil, electric, etc.) Many are predicting another ramp in energy come the mid-to-late 3rd quarter. So far – the question is not what to buy, but rather when to buy.

____________________________________________________
Futures Pre-Market

We are seeing the futures get a good pop in the pre-market – as oil comes off and we held some key supports (mainly in the RUT). The question is what is the FED going to do. Expect a pop in the cash if the spreads remain as ARB traders short futures into the opening to buy the cash basket.

___________________________________________________
Support / Resistance

We held all the key supports yesterday – a fairly good sign – and now the futures are showing a good bounce off those levels. However, that does not mean we have found a bottom or that volatility is now gone – Bernanke is talking and even his own members are not happy – so we could see ANYTHING happen – expect VOLATILITY.

INDU 11,000-11,250 / 11,500 (We held the 11,250 and are getting a good pop this morning. We could see some big moves today – so watch both the 11,250 and 11,500 level)

NDX 1800 / 1850 (This could be a volatile day – we held 1800 – but anything goes today when Ben speaks.)

SPX >>>>1250<<<< (This is THE STRADDLE strike – we are NOT going to sit here – but rather move VIOLENTLY away from this line up or down – this is about GAMMA)

RUT 700 / 720 (You want to see if money rushes back in or out? Watch the 700 and 720 area – this will be the big indicator as to money flow.)

___________________________________________________

Conclusion

My gut is saying that either Ben is going to unload a shocker and either raise the Target and leave/lower the Discount rate OR he keeps it unchanged and talks tough – and then we will see some other members of the FED come down on him like a ton of bricks. There is dissention among the ranks – that means only one thing – MORE VOLATILITY. When the FED can’t even agree what to do, since Bernanke has taken on the role to be everyone’s new savor (bail this out, bail them out, give them money, help them out) – he doesn’t not want or will not let anyone fail all to the determent of the dollar and inflation.

Something has to give and we may see a revolt if he leaves things unchanged – tough talk is now just weak sauce.

Expect VOLAITLITY. HEDGE HARD DELTAS.

The probability of a 3% up or down move is in the cards today – we could even just see it as one big intraday move!