Reacting to the Fed

(This was also posted on the TIE InvestorVillage Message Board by me this morning).

I really believe that traders don't give two hoots about whether the Fed cuts by 25 basis points or 50 today. It has been about the wording of the statement that matters. The CNBC talking head frenzy is almost funny about what people think (25 or 50?), but a few get it right in my view that the wording is important.

Here is the statement from the last Fed meeting on Halloween:

The Federal Open Market Committee decided today to lower its target for the federal funds rate 25 basis points to 4-1/2 percent. Economic growth was solid in the third quarter, and strains in financial markets have eased somewhat on balance. However, the pace of economic expansion will likely slow in the near term, partly reflecting the intensification of the housing correction. Today’s action, combined with the policy action taken in September, should help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and promote moderate growth over time.

Readings on core inflation have improved modestly this year, but recent increases in energy and commodity prices, among other factors, may put renewed upward pressure on inflation. In this context, the Committee judges that some inflation risks remain, and it will continue to monitor inflation developments carefully.

The Committee judges that, after this action, the upside risks to inflation roughly balance the downside risks to growth. The Committee will continue to assess the effects of financial and other developments on economic prospects and will act as needed to foster price stability and sustainable economic growth.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Charles L. Evans; Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; William Poole; Eric S. Rosengren; and Kevin M. Warsh. Voting against was Thomas M. Hoenig, who preferred no change in the federal funds rate at this meeting.

In a related action, the Board of Governors unanimously approved a 25-basis-point decrease in the discount rate to 5 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of New York, Richmond, Atlanta, Chicago, St. Louis, and San Francisco.

So what should we looking for this time? Well, this is all about whether the Fed is on the same page as the market.

Note the 1st paragraph last time around. The comment about "strains in financial markets have eased somewhat on balance" has got to go. Clearly the financial markets are as bad, if not worse that last August. The LIBOR and the commercial paper markets are under tremendous pressure. A realization by the Fed that more work needs to be done here will be important.

Secondly, the third paragraph is out of step with what the market thinks. The wording that "The Committee judges that, after this action, the upside risks to inflation roughly balance the downside risks to growth" may sound good to inflation hawks, but it signals to most that the Fed is behind the curve. Balance? What Balance? The mortgage market is frozen. The risk of recession is serious enough that the market will want the Fed to address the wording to suggest that further easing is very possible to generate growth and stabilize the financial market.

The message is everything. The first move at 2:15 pm may easily be a head fake. It is often about folks that are looking at the headline (25 basis points or 50 basis points). The market will move with the wording and that takes a moment to understand.