The Fed is enjoying some unusual popularity these days. Normally, our central bank operates in anonymity. Sure, Alan Greenspan was a relative rock star. Yes, we have all kinds of mythology about Fed rate moves and their impact on stocks. But how much do you normally think about central banking functions and monetary policy?
Yet today, many investors believe Super Fed must come to the rescue. Convinced liquidity is drying up and the era of cheap, easy money is decidedly at an end, many believe a Fed rate cut will bail out subprime mortgagees, end the "credit crisis," and save the day. In our view, a greater threat is not trouble in high-yield credit markets, but a major monetary policy error or aggressive, free-market-stifling legislation (as we covered in "Bearing with Bulls" 08/14/2007). With so much sudden attention on the Fed, are they likely to cave to investor fears and "fix" the credit market through a series of aggressive moves? Nah, probably not. (Keep in mind, a move in either direction of 25 bps is simply normal Fed tinkering and not troubling.)
We've covered here extensively why investors are failing to scale the subprime and so-called credit crisis correctly (e.g., "Blood in the Alleys" 08/09/2007, "Credit Crisis Conundrum" 07/12/2007, "House of Horrors" 06/28/2007 to name just a few). The following article provides yet another perspective on just how little impact subprime woes have on the economy and the market.
We particularly like the chart detailing the relative size of total mortgages to subprime to total foreclosures. The media loves sad anecdotes of homeowners strapped and in danger of losing their homes. But the truth is delinquencies are at their 25-year median, i.e., nothing remarkable or new. Delinquency and foreclosure rates have been higher than they are today—plenty of times—and it hasn't led to anything insidious. There's nothing saying today's delinquency rates, up from historic lows of the past few years, must lead to economic and market ruin.
So why would the Fed aggressively lower rates based on a small portion of the market and perfectly normal delinquency rates in aggregate? We don't profess to be experts in divining the Fed's future moves. But since Greenspan, the Fed's been very upfront about its plans. In all of the Fed's recent statements, they've indicated they believe the economy is fine and they're more focused on managing inflation, as is reiterated in this article:
We cannot see the current Fed suddenly opening the floodgates by dropping rates drastically, or, more illogically, tightening aggressively. We could be wrong. The Fed might meet in secret next week and do something really stupid (again, "stupid" is not a rate jigger or a cash injection—that's normal). But we doubt it. If the Fed's main concern is managing inflation, it's a sign they still see our economy as likeliest to continue growing. We agree! A handful of lenders and a few narrowly-focused hedge funds going belly up isn't proof the world's ending. Companies go belly up all the time. Hedge funds even more so!
What we should fear are gross mistakes and stupid policies. We have little faith our politicians have much self-control, but the Fed seems to be behaving logically at the moment as credit markets weather some jitters. Let the market panic ("Pray for Panic" 08/10/2007). With the likelihood of a Fed error currently low, and Congress unable to get much of anything passed this year, major threats to the market seem well contained right now.
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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.