Will He or Won't He?

Just about everyone says the Fed will ease on September 18. A few, including a Wyoming newspaper, think the Fed may announce an ease at Jackson Hole tomorrow. See http://www.jhguide.com/article.php?art_id=2144. Highly respected Ed Hyman says that with inflation concern subsiding the Fed will ease to avoid a recession. Growth will trough at 1.5% and, with the Fed in ease mode, that will be good for the market. The out of consensus part of his call is his optimism about the market. There's a video interview on Bloomberg but here's the short story...

Aug. 29 (Bloomberg) -- The Federal Reserve will probably cut its benchmark interest rate to 4 percent as slowing U.S. economic growth restrains inflation, said Edward Hyman, chairman of International Strategy and Investment Group.

``They will start to ease in a measured way, 25 basis points every meeting,'' Hyman said in an interview in New York. ``I think the economy will react favorably to it.''

Hyman said he sees a ``better economy next year,'' with stocks and Treasury yields rising. Slacker growth this year will ``put inflation aside'' as a concern, he said.

The deepest housing recession in 16 years is weakening the economy after the Fed raised its benchmark interest rate 17 consecutive times from June 2004 to June last year.

As global credit markets seized up, the Fed on Aug. 17 lowered its discount rate. Traders are betting on a reduction in the federal funds rate, currently at 5.25 percent, at the Fed's next policy meeting Sept. 18.

``I do not think we will have a recession,'' he said. ``I think it will go to 1.5 percent growth. That will be the low point.''

While it oversimplifies anyone's position to say the a Fed ease equates to a good market, the consensus view seems naïve. I think that previous tensions in the markets that were soothed by the "Greenspan put" were different from today's environment. They were more purely about liquidity. The issue today is different if only because the liquidity event is so much more widespread that nearly every financial institution is affected. If you gave away capital today it would be deployed differently from past years. Another difference then is that this time, risk has truly been re-priced. A Fed ease at this juncture would send a negative signal about the markets ability to gracefully conduct that re-pricing.

So far the real damage has been to those who have made big mistakes, from the poor chap who bought twice the house he could afford to the fund manager who threw a levered laugh at risk. Maybe the severity of the situation dictates a prompt Fed response but weigh the anxiety we all share against 1) the fact the S&P is still up about 3 percent this year and 2) the Fed's determination to kill the Greenspan's put. The last thing the Fed wants to do is spark a rally.

So we don't know if the Fed will be extraordinarily reluctant to cut the Fund rate and if they do it will be because of dislocations so severe that they will not warrant celebrations by the market. For example, a lot of asset-backed commercial paper rolls over tomorrow, about twice the amount the market has been able to digest in recent days. Bank conduits' ability to issue ABCP is a measure of banks' willingness to lend to each other. If that market failed, that could induce a move but don't jump for joy; that would be a frightening turn of events.

The market, which showed such glee at BAC's investment in CFC, has reconsidered. The failure of private capital to instill confidence will figure prominently in Bernanke's calculation too, we think. That doesn't make it good news.

So beware of an ease. Don't confuse a Bernanke ease with a Greenspan put. It won't work this time.