Fed Fumbles
Research for Online Investors

by John Dalt

8/11/10

I hope you enjoyed the “Cash Flows” articles the last two days.  The main point was the affect the Federal Reserve has on the economy, fixed assets, and the stock market (equities).  I agreed with the opinion of Thomas Hoenig, Kansas City Fed President that it was time to raise the short term rates.  This would have minimal effect on the cost of money for commercial or individual borrowers.  The benefit would be to squeeze the interest rate spread on banks.

For the last year, banks could borrow money from the Fed at 0.00% to 0.25% and buy 10-year treasuries receiving 3.5% to 4% interest. The Federal Open Market Committee (FOMC) sent a signal yesterday that the economy is weaker than previously thought. Rather than raise short term rates, they announced they would use up to $1.3 trillion from maturing mortgage backed securities (MBS) to buy treasuries.  Investors have taken the Fed's advice and are running scared from the market at open this morning.  The Fed's statement has raised fear about the U.S. economy.

Since the market top in April, the 10-year treasury interest rates have been falling.  This is expected, because investors moved money out of equities and into fixed term investments out of fear the market would fall and cause losses in capital.  The safety of treasuries, even at a 3.5% yield is attractive to some compared to the roller coaster of the stock market.

The TLT etf reflects the value of 20-year treasury bonds.  It moves higher as interest rates move lower.  Since hitting its 52-week low of $87.30 on 4/7/2010, the bond etf has rallied, but we can probably expect the TLT to hit new highs in the coming weeks.

We have all learned not to fight the government, the knowledge is as common as “Don’t fight city hall.”  In this case the Fed has an endless supply of money to exert their will on the market.  They can always print more!  We don’t have the same staying power!

Another point to remember, bonds act like a commodity. There is a limited supply (this is a stretch) and the price is set by the last bidder. When there is an oversupply the last bidder can scoop up a value. When there is a shortage, the last bidder will compete with others as the price rises because of demand.

Today the 10-year Treasury bond pays 2.703%.  This is down from 2.9% last week.  The Fed wants to squeeze the banks even more.  They are going to push the interest rates down on these bonds to dry up profits on the banks.  The beauty of their action is it accomplishes exactly what I thought should be done, but tilts the scales to very cheap interest for commercial and personal borrowers.

This should help the market and the economy. Lower interest rates make it harder for investors to justify buying bonds, driving them back to equities. Today the market is selling off on concerns the economy is slowing more than previously thought.

Funniest thing I saw today:

Greg Gutfeld, a New York journalist wants to open an Islamic gay bar next to the planned Cordoba House Ground Zero mosque.  Possible names:

Ground Queero
Jihard
Who’s your Baghdaddy?
Infidel-ity
Sixth Pillar
Imam4Imam
Bar Van Gogh Gogh

The name "Cordoba" comes from the 10th century when Islam ruled the southern part of Spain. To quote Wikipedia, “State-sponsored raids into neighboring Christian kingdoms were very lucrative.”  It doesn't seem like a good name to put on a “peaceful” Islamic Center that “seeks to advance reconciliation and understanding.”  But....what does your editor know?

The information presented in this newsletter is based on generally available news releases, corporate filings, current events, interviews and the editor’s opinions.  It may contain errors and you should not make investment decisions based solely on what you believe you have read here.  Do your own research, it is your money.  If you lose it, it is your responsibility, not ours or your grandmothers!  The editor may or may not have a position in any securities discussed.  The editor may have held a position in a security earlier, or in the future.

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