Tuesday, August 28, 2007


Historically, the "big move" starts 30 days after a cut in the fed funds rate. Based on prices in the futures market, the fed will cut at the September 18 meeting. Prices suggest the FOMC will cut again in October and the Fed Funds Rate will be down to around 4.5% by year end.

I continue to sing praises for the job done by the FOMC under the leadership of Ben Bernanke. A good way to describe the actions of this fed is with the word smooth. Greenspan's last act was to coach the Fed Funds Rate up to 5.25% with quarter point moves. In the past, the moves were more violent. Bernanke has since held steady. Allowing the markets to "catch up" with the FOMC. In reaction to credit problems, the FOMC lowered the discount rate, which is the rate at which banks can borrow directly from the government, but they did not lower the fed funds rate.


The numbers due from the housing part of the economy are expected to show more weakness as a result of the credit crunch. Many a potential home buyer now erroneously believes that mortgages are not available. In truth, now is a good time to buy a house if you need one. The traditional mortgage is still very available. The traditional mortgage requires 20% down payment. Other more aggressive mortgages are still available but the teaser loans that were offered by mortgage brokers over the past few years are gone.

The numbers to be reported will be bad but they will also mark the bottom of the housing market. Baby Boomers are still in the market for second homes. Generation Y members are still in the market for their first homes. The sharp decline in new construction and the continued growth in total demand will gradually work off the excess glut of homes. The key fact is that jobs, jobs, and more jobs are still plentiful. If we had people in America to do the jobs, our economy would grow at a faster pace. In the absence of an effective immigration policy, many a new project is being forced over seas. Still, the average wage earners real income is rising at a steady clip. The housing market will rebound quickly as soon as the news media stops telling the world that the housing market is falling apart.


The stock market is rocking back and fourth between "old plays and new plays". Yesterday was an old play day. Energy and material stocks bounced and the rest of the market did less well. It still takes only a small refinery problem to send this "inflation complex" jumping.

The average peak of the hurricane season is September 10. Between now and then, we can expect continued volatility in the price of oil. We also know that when congress comes back to town, Democratic leaders such as Chris Dodd and Charlie Rangle are chomping at the bit to "FIX THE PROBLEMS WITH AN EXPANSION OF GOVERNMENT". One idea that will be hard to beat down is the idea of government subsidy of mortgages by allowing the expansion of ownership by the quasi government companies of Fannie Mae and Freddy Mac.

The congress has a lot on its plate. Basically the entire budget of the US Government and the funding of it needs to be settled in about a month. One of the bills that interest me is the funding of the new, satellite based air traffic control system. This new system will be similar to the GPS systems in cars. The plane will know its own exact location relative to other planes in the area and the air traffic controllers will also see a precise picture. Where this system has been implemented, accidents and near accidents have been reduced by 40%. The system will also save the airplane operators hours of flight time. One reason the delays have been long is because, under the current radar system, distances between planes must be kept large.

The big question is the funding of this 18 Billion Dollar system. Right now, airline passengers pay a 7.5% tax on each ticket. This means that a corporate jet flying just a few passengers takes many of the prime landing times while under paying for air traffic control, it takes just as much time, effort and energy to service a corporate jet as it does to service a 777.

Often times, normal economic cycles are exaggerated by the acts of congress. For example, the kick off to the first phase of the real estate cycle, the down phase, is typically accompanied by tax increases by the congress. The big down phase in real estate is still at two or three years away but we already know that the congress is planning to let capital gains tax breaks expire. In the airline area, congress took away the landing rights of the big carriers back in 2000, just before the airlines went bust and it is likely to restore some level of fairness by the September 30 deadline. A fair bill will be great news for the big carriers. It is hard to compete when the government offers corporate jets a subsidy. The average ordinary citizen who does not fly on corporate jets is tired of waiting on the tarmac while the rich take their spot without even paying for it.


Because the FOMC has played this cycle smooth, the ups and downs have not been nearly as tall as the typical mid cycle turn. Perhaps the turn still has more to go, in terms of time and movement. It is hard to tell. The pundit consensus is that the FOMC will be forced to cut at the September 18 meeting. The market would be sorely disappointed if it did not. The price of basic materials and oil in particular would take a hit. By maintaining a steady hand, this Fed Chairman would build a strong reputation as an inflation fighter. In truth, this Fed Chairman is only the first violin player in a big orchestra. The big sounds coming out of China still need to be orchestrated with the rest of the world.

I do not want to exaggerate the situation in China. The rate of inflation in China is not too bad while the economic growth rate is still incredible. I suspect Ben Bernanke and a number of other central bankers would like to a little moderation in China before backing down rates. Ben has already stated that he expects economic growth in the USA to slow during the second half of the year. The second quarter was almost a barn burner with real growth of better than 4%. Four percent growth in the middle of a serious housing and auto slump. In the old days, a decline in housing and autos at the same time was not possible without putting the whole US economy into the tank.

Again, no one knows how badly the recent sub prime mess will spill over into the rest of the economy but my belief is that the strength in the world economy will continue to provide the spill over effect. NEVER BEFORE IN HISTORY HAS THERE BEEN SO MUCH INTERNATIONAL COMMERCE! How can we believe the US economy is going to be in recession when our exports are growing at an annual rate of 11%!!!!!

I read a wonderful chapter last night. I forgot to note the name of the book but I recall that the title asks an economic question about Sex. Anyway, the author notes that he has recently started to travel a couple of miles to a neighboring town because it has a new Barnes and Noble book store. He notes that since this store was built that he has had a new steady trade deficit with this town. He does not understand all the excitement about trade deficits as he has much enjoyed the books he bought at the Barnes and Noble. On the other hand, his neighbor recently took a job at the Barnes and Noble and is enjoying a significant trade surplus with this neighboring community. Both the author and the neighbor are very happy. They are both better off because the store was built.

This is the nature of the new international commerce. The USA is not the only country that is enjoying dramatic growth in exports. Indeed, many nations are. The results benefit all. In this situation, the law of comparative advantage works its magic, more goods and services for more people at lower prices for all.


Predicting the exact actions that taken by the FOMC is a silly game. The FOMC knows more about the conditions of the economy than any of the rest of us know. Conditions may change between now and then. More importantly, conditions are ripe for a continuation of dramatic world growth. Corporate profits are likely to stay strong. Inflation is likely to stay relatively mild. Larry Kudlow, on CNBC, continues to speak of the Goldilocks Economy. He is pretty close to the mark. There are likely to be a few more bumps in the weeks ahead as the pressure is still on those who purchased homes with little or no money down and the pressure is on those who leveraged the purchase of these mortgages using short term paper. At high leverage, even a small change in spreads can hurt or help a lot.

Bernanke has arranged for credit to be available to those who are sound enough to buy up the "bad paper". The buyers will do well. The great majority of the principal and interest on these loans will be paid. The economy is simply too strong for the housing market to collapse. Before it becomes clear that the worst is over, the stock market will soar!

Remember the history shared above; the stock market liftoff is normally about one month before the first cut in the Fed Funds Rate. Since the FOMC did not over do it on the way up, it may not need to cut. If it does not need to cut, the reason will be that the economy is more than strong enough. The action you need to take to profit from this situation is to BUY, BUY, BUY. Even if there are some more bumps in the weeks or even months ahead, a year from now you will be looking back at very nice profits. THIS IS MY ADMITTEDLY AMATEUR OPINION! BUY BUY BUY!