Posted by Joseph Y. Calhoun, III

From Merriam Webster’s On Line Dictionary:

Reserve - To hold in reserve: keep back; to retain or hold over to a future time or place.

The Federal Reserve officially cast aside the last of their reserve today. The decision of the FOMC to cut interest rates yet again, basically to zero, means that we won’t be in suspense at the next meeting. The odds of a rate cut at the next meeting, and for the meetings that follow for the forseeable future, are zero. While they can’t officially cut rates into negative territory, the actions they announced in the accompanying statement amount to the same thing.

The focus of the Committee’s policy going forward will be to support the functioning of financial markets and stimulate the economy through open market operations and other measures that sustain the size of the Federal Reserve’s balance sheet at a high level. As previously announced, over the next few quarters the Federal Reserve will purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand its purchases of agency debt and mortgage-backed securities as conditions warrant. The Committee is also evaluating the potential benefits of purchasing longer-term Treasury securities. Early next year, the Federal Reserve will also implement the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses. The Federal Reserve will continue to consider ways of using its balance sheet to further support credit markets and economic activity.

What this amounts to is that the Fed will be printing money until such time as we are forced to spend it. Based on the rapid fall of the dollar after the announcement, that may not be very long. If the value is dropping, there isn’t much sense in sitting on it. Here’s the Euro versus the dollar:

Yesterday, I said the Euro might see some resistance at 1.4 but we blew through that today. A pullback is still possible, but the Fed’s announcement today makes it less likely.

While the Fed can  print money, it has little control over where it goes as can be seen by the chart of the gold ETF (IAU) today:

Disclosure: We are long IAU for our own account as well as client accounts.

Gold is also at a resistance point around the 200 day moving average, but if the dollar keeps falling, gold will likely keep rising.

What the Fed is trying to do is to force down interest rates so low on safe investments that investors are forced to take some risk. Most risk assets rose today. Here’s a chart of the corporate bond ETF (LQD):

Disclosure: We have clients that are long LQD.

Stocks were also up big after the Fed announcement with the Dow closing up 359 points. Treasuries and mortgages rallied; if the Fed will be buying them why not get ahead of the curve? Mortgage rates are dropping rapidly and if you have any plans to refinance, you might want to hold off a bit on that. I expect the 30 year mortgage rate to drop under 5% soon and it could go even lower. Obviously, the Fed wants housing prices to stop falling. That would be a good thing for existing home owners (roughly 65% of Americans), but what about the people that want to buy a home?

The housing numbers released today show that the home building industry is already taking the necessary action to reduce inventories. The number of homes being built for sale is running at about 120,000 less than the annual sales rate and the sales rate is historically low. If the Fed is successful in stimulating demand for housing, the inventory could be used up fairly quickly. But will they be successful? As the Economics Babe pointed out to me today, mortgage rates don’t make much difference to someone with no income. Liar loans are so yesterday.

I’m not sure what the Fed will accomplish with these actions except to drive down the value of the dollar and drive up the price of gold. Other commodities may also start to rise and in an environment of weak growth, that doesn’t sound like a good thing. Maybe the Fed is right and we will all start borrowing money and spending it willy nilly again, but it doesn’t seem likely. More likely it will just result in some form of inflation. Where’s the next bubble? Gold? Mortgage bonds? Treasuries?

Update: My daughter called from college today. She’s an art major freshman at San Francisco Art Institute. When she asked what I was doing, I told her I was watching the Fed cut interest rates to zero. Her response? “Are they nuts? Don’t they know that’s what got us in this mess?” I told her she should take an economics class so she can become Fed chairman someday. She said, “Clearly that isn’t necessary”. If a teenage art major can figure this out, why can’t Ben Bernanke?