Hi folks,
Welcome to the weekly issue of ‘What The Hell’s Going On?’

Last week the markets treated Fed initiatives like it was free Guinness with a Viagra chaser. But on Monday investors reacted to further helpful measures from the Fed like it was a night out with Heather Mills. Last night the Fed cut rates by a further 0.75%, to 2.25%. American’s loved it, sending the Dow up a massive 420 points, but will it last?

Background
Just a week ago central banks announced co-ordinated action to pump hundreds of billions of Dollars into the world’s financial markets (No One Wants Fannie Anymore). This led to a euphoric rise in equities and the biggest 1-day percentage gain on the Dow in 5 years. Markets failed to hold these gains, but traded in a 2-300 point range.

On Friday we were greeted with the news that the Fed, through JP Morgan, was bailing out Bear Stearns. Again, the immediate call was to send shares higher. That was until someone pointed out that Bear Stearns had previously denied it was in trouble. The reaction was pure Homer Simpson; the Dow started to edge lower as the cogs in the thought process slowly ground into action….

“Bears was in deep sh*t, but this had been denied earlier in the week. So other firms could be in trouble, especially if they denied it. And if Bears, and others, are in trouble how are their trade positions going to affect the market? Annddd, if other banks are thinking this, then they probably won’t even shake hands for fear of being associated with a failing bank, let alone deal with one another.”

The penny dropped and so did the Dow, by 450 points. Other equity markets followed, the Dollar sunk, like Eddie O’Sullivan’s rating, to new lows and gold and oil became everyone’s best mate.

Not Everyone Was Watching The Rugby
You know when you work your nuts off to please the missus, only for it to backfire? Well, d’you reckon some of the Fed guys felt like that on Monday morning? They’d probably been working all weekend on the Bear Stearns rescue plan. They then came up with a whole A la Carte of new measures designed to provide further help to the financial sector (If you care, there’s a small section on the latest measures below. If you don’t, roll a 6 and pass on to the next bit). So imagine how they felt, apart from very tired, when markets crashed on the opening; the Nikkei fell 400 points and the Hang Seng plunged nearly 900 points. European markets took on the baton and fell to close at their lowest levels this year (the DAX hit a new 1-year low). The Dollar hit more record lows and gold pushed further through the $1000 barrier, briefly breaking $1030.

Something For The Weekend Sir?
Here’s the 60-second version of what the busy New Yorkers were hammering out while we watched the rugby:
1) JP Morgan agreed to buy Bear Stearns for $240m; the Fed chipped in with $30 billion towards financing the crappy bits that no one wanted.
2) For the first time in its history the Fed agreed to lend directly to the 20 firms who buy Treasuries from it (they’re called primary dealers and include the likes of Goldmans, Merrills and Morgan Stanley). This facility, allowing primary dealers to borrow from the Fed at the discount rate will be in place for at least the next 6 months.
3) The aforementioned discount rate was cut by 0.25% to 3.25%, just above the Fed funds rate.

So Why Did All The Toys Come Outta The Pram?
Well, let’s start with the supreme irony; last week’s action by the Fed to lend bucket loads of dosh in exchange for all sorts of tat would probably have saved Bear Stearns. But the Fed’s new ‘miracle grow’ wasn’t available until March 27th and poor old Bear Sterns couldn’t survive that long. Bears needed to borrow and no one was prepared to lend. Worse still, hedge funds and other clients were rushing to pull their money out while they still had chance.

Monday’s panicky moves were on several concerns:
First was the shock that Bears had been taken over and at such a low price. The race to revalue other banks was based on the assumption that Bear’s balance sheet was worth just 10% of its previous market value. One top analyst chimed that banks probably had another 50% to fall in market value.

Just like the Northern Rock debacle, the first move was to trash any stocks with a similar business model. Lehmans bore the brunt, its shares falling 35%, but in the UK HBOS shares ended 12% lower and in Ireland Anglo Irish suffered a 15% mark down.

Then there were the usual concerns that the Fed must be really worried to bring in these extra measures and that if the banks didn’t trust each other then investors should keep at least a barge pole’s distance away.

The Fed’s Clever Bluff
On Tuesday The Fed cut rates by 0.75%. Earlier in the day a bruised and battered market was relieved that results from Goldmans and Lehmans both came in better than expected. This allowed a cautious rally and was the perfect hors d’oeuvre for the Fed’s main course.

Learning from Monday’s ‘too keen puts them off’ mistake the Fed played it cool; it cut rates by 0.75%, rather than the 1% the market had been building in. Accompanying the move to 2.25% rates, the statement painted a more relaxed picture than Monday’s announcements.

The view that ‘downside risks to growth remain’ was balanced with concern that ’some inflation expectations had risen’. The door to further cuts was left open (anything else would have been raving bonkers) but with the suggestion that these cuts would be to ‘promote sustainable economic growth’ rather than ‘to address downside growth risks’, mentioned in the previous statement.

By showing that it’s not so worried as to cut rates by the full percentage point, and that it hasn’t forgotten about inflation,the Fed played a clever balancing act. Following the better results from Goldmans and Lehmans, investors were prepared to treat Bear Stearns as the odd-man out.

I don’t know whether Bearded Ben Bernanke had a sneak preview of Morgan Stanley’s results, due out later today, but I’d be amazed if there hadn’t been a quick phone call along the lines of, “Is there anything you should tell us before we cut rates?”

How Am I Trading It?
First off, a confession. I got it wrong last night. I dealt a few times, but the net result was to increase my short in FTSE. I misread the mood and thought the market would be disappointed with ‘only’ a 0.75% cut. So, bear in mind I’m a cynical grumpy old bear.

I’m still in the camp that reckons a bear market is peppered with sharp rallies; investors have a defect that makes them more inclined to buy than sell. Also, we need to be aware of possible calendar effects. How much risk traders want to wear going into the Easter break will have some effect.

And another thing, the big boys (the big fund management houses) set a lot of store by quarter-end valuations; that’s often what determines their bonus payments so they prefer higher prices.

But none of this will count for much if rumours continue of banks in trouble; as I’m finishing this article there are stories of a UK bank in trouble. HBOS has denied this, but so did Bear Stearns. Yesterday, members of the Bank of England cancelled speaking engagements so that they could remain on hand.

I’m short and happy to be so; my stake is small enough to live with the short term pain of exuberant rallies. A convincing break of 5700 might force me into a re-think, but there’s still a lot of pain out there.

Remember, the fat lady’s nowhere near singing, it ain’t over yet!