Mr. Bernanke's Fed. Bravo!!!

The FOMC statement issued Tuesday August 9, 2011 at around 14:15PM was dissented by three committee members. It initially stirred confusion in all markets. Equity markets were taken by surprise as they focused on the bleak economic outlook the Fed suggested.  The Dow was down 200 points, shedding almost 450 points in 30 minutes before recouping after watching the Treasuries' plummets and appreciating the insight that maybe equity yields were favorable investments after all.  At the end of the day, the Dow had rallied back over 600 points. It was a session marked with enormous market volatility. Dow closed the day 430 points higher in the most dramatic session in decades.

The same announcement shook short date (2 years and less) Treasury markets dramatically,  generating yields that camouflage Short date Notes as fed funds- zero coupon- for all intents and purposes, and sent the US dollar into a tailspin against the meek Swiss Franc and roaring Gold,  after market players correctly interpreted that the Fed was capping rates at near-zero for the next 30 months until the end of Mr. Bernanke's term.

Most observers also correctly felt that the Fed intentionally avoided sabotaging already nervous equity markets that were showing promise with substantive earnings and a sufficient capital base. The Fed action was seen as creating favorable portfolio opportunities  for money managers to retain good yielding equity that confirm good earning and dividend profiles. The Fed idea was not to undermine potential economic benefactors and job creators. Quantitative Easing 1 (QE1) and QE2 had already successfully channeled funds through the system and filled corporate treasuries with low cost capital which is supporting the already fragile recovery. 

Others perceived the Fed move as a preparatory scenario for an another QE3-fielding the necessary signals to the market, keeping available liquidity for timely Bond releases.

Notwithstanding the above probable explanations, I think Mr. Bernanke and this Fed were engaged in a more extraordinary exercise and endorsing a more subtle stance that blindsided a myopic market, naturally  focused on its malaise. Mr. Geithner had already voiced his concerns that exogenous factors existed which also influenced US markets. Mr. Geithner minced few words when he warned the markets that European contagion was a real threat to a global recovery,  much greater than the immediate slowdown in the US economy. It was confirmed by all Central Banks that if Italy failed to refinance it might mark the collapse of the eurozone and generate a systemic collapse. The Fed was aware, as was the Treasury, that ECB and the EFSF resources would not suffice to cover the Italian and Spanish risk, if and when (within 2 years) they surfaced. There is only one player in the world that can assume the role of backstop required by the situation: enable the Eurozone to stay afloat in case of overwhelming risk, and  keep Germany, France and Italy from following into political and economic disarray, and from sending the euro through Hades, and many to Dollars and Gold,  SFr and maybe yen-but how much liquidity can they carry. The same can be said of gold: how much demand can it support.  European contagion would also dramatically undercut the engines that drive emerging market momentum which, at present, supports some of the global economic growth. Intrusion of the Fed in the short dates would have unnecessarily squeezed  Italian and Spanish offerings. It may just be that the US has saved the Italian offering.

The Fed's move was larger in scope and more daring in nature than meets the market eye. Perhaps, Frau Merkel can be more accommodating in tone when she reacts to the 'problems' in US markets and the challenges of the US Government.