[DcifrThs]

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Well, I really have no opinion in terms of pro/con, you are getting into some pretty hairy stuff. But I would mention a couple of things to keep in mind wrt the Fed:

1) Bernanke establishing reputation as inflation fighter -- You always hear that the new guy at the Fed needs to prove to the markets that he is serious about inflation early on so he'll be credible down the road. To the extent this is true, the Fed might exhibit a short term bias for a higher fed funds rate than otherwise. I think this is pretty plausible although I'm not sure if there is any real evidence of this. Also, Bernanke came into the job w/ a strong reputation as an inflation fighter so he probably has less need to establish the reputation than, say, Greenspan when he first took over.

2) Liquidity -- I don't really know what is going on wrt to these SIVs, CDOs, etc. Which is not surprising or significant. But I'm also not sure ANYONE knows what is going on here and that is a little scary. Wrt the Fed, it makes it harder to predict how they will act in the future since they might be considering a lot more than the usual inflation/growth tradeoff. For example, some have said the Fed needs to cut not so much to stimulate growth, but to increase liquidity.


Bottom line: Good chance to kill or be killed if making financial bets in the near term.

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right, and that is all good in a vacuum, but bernanke has to make the growth/inflation tradeoff during times of high stress. he does have leeway for this since the past generation is so used to anchored inflation expectations that lower rates won't drive up near term inflation expectations anywhere near what they would be longer term (i.e. 2yr inflation expectations are probably pretty well anchored so the fed can lower rates without driving the expectations up too much...but inflation is volatile on a longer timeline than growth so longer term inflation expectations are likely to jump up steepening the yield curve. i.e. the last fed cut saw a rise in 10yr yields, not a fall)

your points are good though. the problem for bernanke will be in determining whether he has enough leeway w/ anchored expectations to help stave off serious downward pressure on growth.

i think that looking at the fed's (and his) history, he'll err on the side of propping up growth vs. fighting inflation until we see some improvement in the economy.

in terms of the liquidity thing, that is the bet i'm taking in the euribor market since that is seeing the most dislocations. within the next few months i thinkw e'll see these rates settling down to longer term relationships rather than the liquidity scared (oh noes, i be needing dem funds now since i don't know where dem losses will be) super steep 1 vs. 3mo euribor futrues contracts.

keep the comments coming [img]/images/graemlins/smile.gif[/img]

thanks,
Barron