The Fed's Bag Of Tricks

The Federal Reserve meets this coming week. The Fed's interest rate cuts may be only slightly helping the borrowing problems that exist in the economy. This is occurring because liquidity in the credit markets continues to dry up. This dried up liquidity has been caused by loss of confidence from the lenders. Who are the lenders that have loss confidence? And why are they snake bit? In this case the lenders are all of those entities all over the world that participated in the securitization process during the past 5 - 6 years or so. The lenders are snake bit because their loans that they owned decreased sharply in value and large losses were taken. So now they have become more careful. Also they have less capital to give because of the large losses they have sustained already. This brings me back to the Fed. The Fed sees the problems and they know that until the log jam from the credit markets breaks free that the system will not be able to be fully repaired. They know that further interest rate cuts may not help much if at all. Maybe the Fed will come up with some other weapon to work on the credit market problems or maybe the Fed will revert back to one of its other weapons that seem to have given it some traction. Those special auctions seemed to have helped get the Fed some traction. what will they come up with this time?

The WSJ on Friday mentioned that some credit spreads have come down. Notably the junk bond spread which had been up at 9 points fell back to the 7 - 7 1/2 points. They note though that this spread is still way above normal levels of 2 points or so. Another part of the credit markets that I have observed more closely is the Ted Spread. I have both the WSJ and Bloomberg TV to thank for pointing this out - that the Fed watches the TED Spread very very closely. The bottom line - TED under 0.50 is normal, TED above 2.0 is very worrisome, and in between is well in between. What is interesting is that the TED Spread has not stayed this elevated for this length of time since the 1987 crash. It currently is around 1.56.