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Recursion, Reflexivity, Feedback Loops & the Fed

Posted By Barry Ritholtz On September 5, 2007 @ 6:59 am In Credit,Derivatives,Federal Reserve,Inflation,Investing,Markets,Psychology | Comments Disabled

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chart courtesy of Meir Atazur

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I love when graphics can depict a lot of information elegantly. The above chart (via Meir Atazur) concisely conveys three data points: The average monthly return for each year over the past 23 or so, the average September return, and the SPX.

Now, any good statistician will tell you that 2 dozen instances is likely to be an insufficient number to draw a significant conclusion from. However, I find the chart interesting nonetheless, as it reveals somewhat of the quandry both Traders and the Fed finds themselves in.

Traders know this can be a volatile month. And with the Punch Bowl Caucus [2] pleading for rate cuts, stocks have surged — on the belief that rate cuts are about to arrive.

As the market rallies up towards its old highs — the S&P500 (SPX) is now about ~4% of its ALLTIME peak — it becomes harder and harder for the FOMC to give the market what it wants — another hit of that sweet, sweet junk. (YEAH, that’s the spot . . .  Ummmm, good stuff).

The last thing Chairman Ben wants to do is cut rates, as he fears of reinflating the various Greenspan-created asset bubbles.

And before you start screaming Fed Fund Futures, note that since January 2006, there have been half a dozen instances of where the futures were forecasting a cut that never came to pass.

As Bill King notes:

"Bernanke’s really big problem is the busted system, which means previous flows of credit have been altered. Certain entities can no longer get credit no matter how much credit that the Fed creates.

Stocks and commodities are rallying smartly because much of the credit that the Fed is creating now flows to fewer players and those players have fewer vehicles to play.  This is how STAGFLATION turns  into an inflationary recession and income distribution concentrates even further."

Today’s Ahead of the Tape [3] column adds that we remain as "data dependent" as ever:

"When he spoke at the Federal Reserve’s symposium in Jackson Hole, Wyo., Friday, Chairman Ben Bernanke cautioned that recent financial-market turmoil has made charting the economy’s course more difficult than usual.

"Consequently, we will pay particularly close attention to the timeliest indicators, as well as information gleaned from our business and banking contacts around the country," he said. That puts extra weight on today’s "beige book" report — the collection of on-the-ground business anecdotes that the Federal Reserve’s 12 regional banks put together eight times a year.

If the beige book in any way mirrors what some car dealers, trash haulers and diamond dealers have to say, then the economy — while by no means booming — has so far absorbed the hit from financial-market woes. That’s good news for Main Street. But it might not be great for Wall Street, where hopes for a Fed rate cut depend in part on a dimming outlook for growth."

Thus, a cut is far from the done deal its been described as. I give it a 55/45 chance — barely better than even money.

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Source:
‘Beige Book’ Spoiler Alert: Don’t Bet on Cut
[3]JUSTIN LAHART and SCOTT PATTERSON
WSJ, September 5, 2007; Page C1
http://online.wsj.com/article/SB118895285279817580.html


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URL to article: http://www.ritholtz.com/blog/2007/09/recursion-reflexivity-feedback-loops-the-fed/

URLs in this post:

[1] Image: http://bigpicture.typepad.com/.shared/image.html?/photos/uncategorized/2007/09/05/1a.gif

[2] Punch Bowl Caucus: http://www.slate.com/id/2172872/

[3] Ahead of the Tape: http://online.wsj.com/article/SB118895285279817580.html

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