Tuesday, August 7, 2007

Will Bernanke Blink?

The pressure is building as the cold turkey effect of the Fed and Treasury's mantra, the market discipline, is being felt with greater intensity with each passing week and cries of "rescue me" can be heard (see Cramer's tirade from last Friday on youtube for a good example of bellyaching at its best).

As the sub prime debacle evolves into the tipping point for the larger mortgage market mess unfolding, most importantly, the tip of the much larger credit derivatives iceberg still remains well below the surface of understanding. And therein lies the real danger to the global financial system and, ultimately, the world economy. Can the global financial system de-leverage itself without precipitating contagion? Which brings us to today’s FOMC decision.

Those expecting today’s Fed announcement to contain the easy money/Greenspan elixir are sure to be disappointed. Should the Bernanke Fed back off its market discipline philosophy however, then the financial markets will almost certainly celebrate the return of the Greenspan put. If, on the other hand, the Bernanke Fed sticks to its philosophical guns and withstands the pressure to bail out bad behavior, then the risk adjustment process will continue and the balancing act of stability and growth versus contagion will continue.

With growth (global GDP and corporate earnings) still strong, inflation becoming more of a concern, and the absence of the financial contagion reaching beyond Wall Street (broadly defined) and into the traditional banking system and the real economy, my bet is on the other guy, not Bernanke, blinking – as in blinking away their tears.


Scott Richards said...

So you think B will refrain from throwing the market a bone? More importantly, will the market finish up on interpretation?

Vinny Catalano, CFA said...

Yes, Scott. I believe the Fed is thankful that the market discipline is working and that bad behavior is being punished appropriately. As long as contagion remains contained, the Fed is happy to let the market do its dirty work.

re the equity market's reaction: I would expect more downside for stocks if the Fed stands pat with weakness most pronounced in the Financial sector.