The Fed Says Bye Bye to Extended Period, and Yes, We Are Japan

“However beautiful the strategy, you should occasionally look at the results”–Winston Churchill

We have been examining Fed language for years with an electron microscope looking for certain subliminal or not so subliminal “tells” to try and understand policy. We have drilled down their message to a sentence, but in many cases one word to give us an edge. “Extended period” was used by The Bernank for a couple of years now, but we only got a true understanding of the duration of that phrase recently. Ben told us it meant that duration meant a couple of Fed meetings.

Last week the Fed took out the howitzer and said that they will not raise rates for two years. Bernanke has taken the baton that was passed on to him by Greenspan and has given new meaning to notion of cheap money. In doing so, Bernanke has acquiesced . He is admitting without actually saying it, that the economy is dead on arrival and that GDP will be in the tank for a while and the possibility of a double dip may be fast approaching.

Banks will  now continue to play the spread game of borrowing from the Fed for nada and loaning loot to the Treasury and making riskless money. Why loan to Joe Sixpack when you can do this?

Europe is melting before our eyes and it would not surprise me to see a downgrade placed on France soon. According to John Mauldin’s partner, read full piece here, this could be the effect on Europe if that happens:

“If France is downgraded, a number of French banks will almost certainly be downgraded, following which other European banks will face the same destiny. Such a scenario has the potential to cause calamity across Europe. The 90 European banks which recently went through the (so-called) stress test organized by the European Banking Authority need to roll a total of €5.4 trillion1 (!) of debt over the next 24 months. A massive amount even during the best of times. Probably undoable during times of stress.

Of course if this happens it will have a dramatic impact on our markets and will probably make our credit downgrade look like a walk in the park.

The bulls and bears last week had an epic battle as you know. Mass confusion led the day, as evidenced by massive daily and intraday swings. Don’t expect this to stop any time soon, as long as Europe is in meltdown mode.

The S&P landed on the 1100 level this week and managed to rally about 78 handles to close the week off the lows. That support level is now the line in the sand going forward, so keep your eye on it. A break of that level and we will certainly have problems. In the meantime, stocks can certainly trade higher, but a sustained rally I personally think will be difficult as we now live in a headline market and any burst of news, good or bad, can move things dramatically.

I’m still all cash although I traded some things last week and caught a few rallies, before they fizzled. Nothing though to write home about. Capital preservation is job one right now. These last two weeks were a signal and the market sent a big shot across the bow I think. Trading the rallies and staying small in your position size is the best advice I can give you right now.

Good luck next week.

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