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Farrell: Looking Into The Fed's Crystal Ball

In April, the Federal Reserve's statementsaid they "anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period." That was a very clear indication there would be no tightening anytime soon. Since then, the Fed Funds Probability Index has priced in a series of rate increases, and both the ten- and thirty-year bond yields backed up (although both have calmed down). Yet the pace of the economy has not picked up, unemployment is high and likely to rise a good bit, and capacity utilization is at record low levels. There is little chance, in our opinion, that the Fed will be raising rates anytime soon. The statement that will be issued Wednesday at 2:15pm will try to reduce expectations of any rate increase.

The Fed will also, in our opinion, not increase the total it will spend on its repurchase program. Nor will they accelerate the program in place. First, it's arguable the plan has not worked, as yields rose in the face of Fed buying. Second, they still have significant amounts to be purchased, and, also, they do not want to be seen as monetizing the debt. They probably won't discuss exit strategies either, as they feel the chance of inflation is not a near-term threat.

Interest rates have backed up enough to take away the prospect of refinancing mortgages on a massive scale. There is talk of increasing the home purchase tax credit from the current $8,000 (which expires soon) to $15,000, to encourage home buying. That makes sense in that it is big enough to influence consumer behavior. The "cash for clunkers" plan to provide tax incentives to turn in an old car for a new one will not move the needle at all. At $1 billion, it sounds impressive, but it breaks down to aiding about 250,000 car purchases, and, even in today's depressed auto market, that won't make a difference.

Read Carole Berger's piece on the inadequacy of the White Paper on re-regulation of the financial system. Never one to mince words, Carole writes, "we had regulatory oversight before, and not one banking regulator, not the Fed, the OCC, the OTS, the SEC, the FDIC, nor the 50 state regulators, saw the housing bubble coming. Neither did the 50 state insurance regulators." And now the Administration wants to reward the same regulators with more power! On top of that, I saw in the Wall Street Journal on Monday that two Democratic legislators, Barney Frank and Anthony Weiner (D., NY), want Fannie and Freddie to relax standards on the purchase on condos. This is the same Barney Frank who was willing to "roll the dice" (his words) some years ago on allowing Fannie and Freddie to expand into subprime. Do we never learn?

The Chinese are learning some valuable lessons from their American counterparts on how to raise money. There is a proposal to tax some size-purchases of cigarettes at 56%. Now that's a rate that any good American politician would love to be able to inflict.

The market finally rolled over a bit, ostensibly on a report from the World Bank that the world-wide downtrend will be deeper than thought. Maybe. But, as we have been saying, the market was overdue to correct its sizeable 40% surge from the March lows. The optimist will say Monday's decline was on light volume. But volume is a weapon of the bull. You can be rendered destitute just as easily on light volume declines as on heavy ones. We'll stand by our guess that this decline will be at least one third of the advance off the March lows. That would bring us back to the 825-850 area on the S&P. We closed at 896, which "took out" the 200-day moving average at 900 and the 50-day at 898 as well. The market might try to rebound to these levels, but we will probably take a trip to the 100-day at 843 pretty soon.

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