Tuesday, August 10, 2010

Pondering the Great Dichotomy While the Fed Meets

The Fed meets today to discuss its next move in the exciting game of "Re-inflate the Bubble." Sure the Fed thinks it's playing whack-a-mole against lousy economic data. Every time a bit of bad news peeps its head out into the supposedly robust economic recovery, the Fed whacks it down with some other ingenious bit of monetary easing. Our monetary authorities are just looking for more and more ways to flood our financial markets with free money, at the behest of Wall Street, so financial assets will rise in value so all of those underwater residential, commercial and other loans can be refinanced or repackaged and sold without another financial catastrophe. You see, it's working really well. Deflation is our worst enemy. Today anyway. That's what Bill Gross says so it must be true. So if we need another $2 trillion in quantitative easing, so be it. Right?

In the economic bad news/deflation corner:

  • Fannie and Freddie continue to bleed cash, albeit at slower rates than before. After posting their most recent losses, the mortgage lenders increased their borrowing from the Treasury to a total of $148 billion. Mind you, Fannie and Freddie are 90% of the mortgage market, so regardless of the economic health of the rest of the banking sector, the true state of the mortgage market is reflected by Fannie and Freddie's performance.
  • Productivity slowed by a unexpectedly jarring 0.9%. So much for the theory about robust profit growth leading to increased productivity leading to increased hiring.
  • Unemployment remains stubbornly high at 9.5% and will likely not decrease unless productivity continues to increase.

In the good news/inflation corner:

  • Money is flooding the system and investors have nowhere to go with it, so they are just piling into anything reasonably safe with a yield and forcing rates lower. The WSJ has two articles this morning, one on MLP shares ripping on zero fundamental improvement this year and another on the relentless march lower in corporate bond yields. The FT has commentary on how the bottom line at strong companies is getting stronger while weak companies are floundering. Case in point: IBM can issue debt at 1%. Can you?
I call this the Great Dichotomy. Part of the economy is flashing deflationary signs, the other inflationary signs. What's a good Fed to do?

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