Monday, Down In The Fed’s Canteen
Bearded Ben Bernanke is having a working sandwich break with his team:

BBB “Shoot guys. The whole goddamned banking system’s up the creek and we’ve gotta provide the paddle. Give me a quick run down on the latest.”

Team “Dur, OK Boss, the Dow Jones has broken below 12,000 and is heading for January’s lows when that stupid French bank couldn’t control its staff.”

BBB “Cheers Einstein, I can read my screen, but what’s causing it now?”

Team “Well the market’s still panicky after last week’s margin calls (An Eagle, A Black Horse And A Load Of Bullsh*t). No-body wants to lend cos they don’t trust the bonds they’re getting as security, not even the goddamned Fannie Mae bonds. And usually everyone wants some Fannie. And that’s another thing. Fannie Mae’s share price is down 19, yes 19% today. Apparently there’s some article in Barons saying that it might need a rescue package.”

BBB “Well, haven’t we put out the usual rumours of an emergency interest rate cut?

Team “Sure Boss, but it ain’t working. See, the word on the street is that Bear Stearns is going belly-up; credit default swaps (insurance against company default) in Bears are astronomical. They’ve shot up from 246 to 792 points! The boys reckon it hasn’t got enough capital to cover its mortgage losses and might seek Chapter 11 (this isn’t the chapter on how to get out of sh*t street, or how to manage risk in your business, or even how to leave the country with a suitcase full of money. Chapter 11 is a way of seeking protection from being declared bankrupt.)”

BBB “OK guys, the solution’s obvious. It works every time. Send a text message to those guys over in Europe. Oh and see if there’s anyone running the ship in Japan at the moment. We’ll announce another co-ordinated funding program. Chuck in another $200 billion. Oh, and tell the guys on the street we’ll take their crap loans in exchange for Treasuries. That’ll do the trick.”

So What’s The Fed Actually Doing, And Why?
Cast your minds back to, ooh, last Friday, just before the US payrolls data. With extraordinarily dodgy timing the Federal Reserve said that it would add an extra $200 billion to the banking system over the next month.

Two working days later, the Fed magician pulled another $200 billion out of the hat, this time in the form of Treasuries (US government bonds). This new program, called the Term Securities Lending Facility, targets the banks and securities firms that trade directly with the Fed; it will allow them to borrow Treasuries from the Fed using their dodgy illiquid mortgage loans as security.

The cunning plan here is that the banks will feel comfortable lending money to one another if they receive borrowed Treasuries as security. Hopefully this will free up the money markets and help securities firms to finance their operations. Recently, lending between banks had almost ground to a halt due to panic over the quality of collateral being offered. Although this collateral was AAA rated, all but US Treasuries were as easy to trade as a Michael Jackson bedtime story book.

What the Fed hopes this move will do is to buy it more time; it knows that there’s worse news on the economy (and probably on the corporate front) to come, but wants to take the panic out of the market.

Who Else Is In The Gang?
Central bankers around the world were busy text-messaging each other on Monday night. Tuesday’s announcement was a co-ordinated move by the central banks from Europe, UK, Japan, Canada, Sweden and Switzerland. All these banks have made billions of Dollars available in the short-term, with the promise of more to come if necessary.

The Bank of England was already due to re-assure banks with an extension of its loan facility. The Christmas club loans were due back on March 18th and it would have been pure madness not to renew them. The Bank of England said that it would offer £10 billion in 3-month loans in March and would consider offering the same again in April.

The European Central Bank said it would stick up to $15 billion in the kitty, to lend for one month on March 25th.

Will The Medicine Work?
Impossible to say. However, that doesn’t make much of an article so here goes:

The instant reaction suggested that many were prepared to believe in the power of the Fed. Tuesday saw the biggest percentage rise in the Dow for 5 years. But let an old cynic pee on the parade; equities had been pretty oversold in the short-term; the Dow had lost 1000 points in the past fortnight. The market was ripe for a strong rally on any half-decent news.

However, European money rates (Euribor) didn’t fall at all, and on Thursday were a fraction higher at 4.60%. This compares to the official rate of 4% and suggests that banks would still rather hold cash than lend it. In the UK 3-month money is back to December’s levels at 5.84%, compared to official rates at 5.25%.

The dollar’s immediate reaction was to strengthen against the major currencies; the rationale was that this action, plus the expected cut in interest rates, would get the economy up and running sooner than previously thought. But a day later the Euro was making new highs against the Dollar. This has continued with EURUSD now having a sniff at $1.56 and GBPUSD knocking on the door of $2.04. The USDJPY rate hit its lowest level since 1995, dropping below the key Y100 level. So you can take it that the forex boys aren’t too impressed with the prospects for the land of burgers and hummers.

There hasn’t been a sharp fall in the cost of insuring against corporate defaults. These prices were at extreme levels so a reaction similar to the bounce in equities could have been expected if investors had bought into the plan.

Equities haven’t yet returned to their lows, but have lost most of their gains from the announcement. To show how fragile sentiment is, this latest fall was blamed on the failure of Carlyle Capital to reach agreement with its lenders. The consequence of this was for the lenders to take over Carlyle’s remaining assets leaving it in danger of collapse.

None of the previous rallies held

The trouble is that a massive ‘daft lending’ bubble has been rapidly expanding for years. And big bubbles either take a long time to quietly deflate or they explode making a helluva mess everywhere. This move will hopefully ease some of the liquidity strains, but it won’t help a load of unemployed people start to pay their mortgages off.

There’s another problem tugging away at the Fed’s shirt tails; the central bank is under such political pressure to save the Country from its own stupidity (Bush leaves office in November) that it’s turned its back on the other threat, inflation. The fear is that in trying to prevent a recession/ depression the Fed is likely to ignite the inflation demon, sending it back to the high single digits of years gone by. On Thursday gold (that well-known inflation hedge) pushed high enough to reach out and give the $1000 level a little kiss.

So, What’s Rocking My Boat?
In Wednesday’s blog (A Quick One Before The Budget) I said that I didn’t know how long the rally would last for, but that I wasn’t buying into it. I sold £5 Barclays at 458.16p, just below resistance, and wasn’t panicked into closing my short in FTSE.

It’s a given that the Fed will cut rates at their next meeting on Tuesday, and I’m happy to bet my tuna sandwich that it’ll be a 0.75% cut, taking rates down to 2.25%.

Prices might just mess around at these levels, up a couple of hundred, down a couple of hundred. And at some point investors might decide that, given time, the Fed’s actions will do the trick.

But, and it’s a bloody great ‘BUT’, there’s a danger that as things get worse, the markets conclude that the Fed’s running out of ammo.

If that happens I’ll be racking up the shorts in FTSE, banks and EURUSD.

In the meantime I’m happier trading to the short side, but need an electric cattle prod to remind me that sometimes it’s worth taking some profits.

Happy Trading