April 29, 2008
'Do you feel lucky pal?
Well, do ya?' - Clint
In the middle of 2007 I presented
you with a worst case scenario for the longer term
health of the economy. That scenario demonstrated
a weakening economy coupled with rapidly increasing
levels of inflation. Unfortunately, that's exactly
what we are faced with today. Bernake is not only
stuck between a rock and a hard place, but he could very
well be blamed for the 3rd major down period in US
History.
In this article I will explain
exactly when and why Bernake will reverse his stance on
Interest Rates. First though, we should address
his next move. One more 25 basis point cut may
indeed be in the cards, but it will be more of a
response to market demand that economic policy.
Regardless if he cuts on Wednesday or not, the easing
cycle is likely to come to an end abruptly afterwards;
don't expect an increase in rates anytime soon though.
Over the past 10 years the market
has followed the changes in Interest Rate sentiment
dependably. If rates were increasing, the market
moved higher, and if rates were being cut the Market
moved down; usually these changes begin with sentiment
shifts, and that's what we are probably going to witness
after the FOMC rate decision on Wednesday. We have
demonstrated this in past articles.
Review the correlations here:
CORRELATION
Initially that correlation is
likely to continue based on sentiment changes alone, but
not for long. You, as a subscriber, have access to
our Market forecasts as they relate to the Strategic
Plan and the Investment Rate. Those explain the
divergence we expect, so please read them.
The point of this article is to
reveal why Bernake might indeed cut once more on
Wednesday, and when he will start to reverse these cuts
out of the Market again. Our market analysis is
saved for 'In House' commentary.
Let's start by taking a look at an
estimate of Mortgage resets I captured from a May 2007
Article in Housing Monthly:
In the graphic above we can
see that a very high number of mortgage resets will
occur in 2008, but those should subside going into 2009.
The burden of Mortgage payments and adjustable subprime
mortgages as they relate to declining home values has
all economists worried. A borrower would be
encouraged to walk away from his 'underwater' real
estate if his mortgage burden increased beyond his
capacity. Bernake does not want this to happen,
nor do any of the debt holders; that would devastate the
economy. This is why Interest rates are low and
could possibly move slightly lower this week in the face
of rapidly increasing inflation.
One of the major reasons Bernake
is aggressively cutting rates has nothing to do with the
immediate weakness in the economy, or the perceived risk
of inflection, but rather the premise is Mortgage
resets demonstrated in the graphic above.
The
problem: while he is prudently tackling the adverse
impact that escalating defaults would have on the
economy in the future, he is relinquishing his control
of inflation.
Bernake has lost control of
inflation, and unfortunately he will probably not
take steps to reverse the recent aggressive cuts until
late in 2008, when the number of adjustable mortgages
ease; that's too late. In the meantime, Inflation
will get worse while he waits. Inflation is like a
snowball rolling down a hill of fresh powder....it
grows, and grows, and grows.
Our Economy, thanks to Bernake,
may be sheltered from some of the defaults that would
otherwise lie ahead in a higher Interest Rate
environment, and that's a good thing. However,
thanks to Bernake again, inflation may not only offset
his initial effort, but it very well could cause the 3
third major down period in US History to turn into an
even Greater Depression.
The Investment Rate explains why
the Economy and Stock market are already in the 3rd
major down period in US History. This report is
available by clicking the link below.
For more information regarding
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and specific recommendations for making money going
forward, please sign up for a free trial and evaluate
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Good Trading
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