Wednesday, November 28, 2007

Markets Misinterpreting Kohn's Remarks

People are seizing on Fed Vice Chairman Donald L. Kohn's speech today as evidence a rate cut is a sure thing on 12/11. Not so fast.

Here is the sentence people are focused on:

"...such a repricing in the form of wider spreads and tighter credit standards at banks and other lenders would make some types of credit more expensive and discourage some spending, developments that would require offsetting policy actions, other things being equal."

The key words? "other things being equal"

Simply put, if inflation were to jump, a cut is off the table. Should credit and financial institutions conditions improve (Citigroup's (C) have), a rate cut is dead. Think about it. Kohn referred to "recent weeks" in the statement several times. So, essentially if things turn around or stabilize in the next couple weeks until the next meeting, Kohn's entire speech is rendered moot.

The Dow and S&P were both up about 1% early today and I fear it is a matter of people hearing what they want to hear rather than listening to what Kohn said.

A careful read of Kohn's speech really does not shine a new light on anything. His statements are discussion are really nothing that have not already been discussed and when you condition a statement on "things being equal" you are essentially saying "if we had to act today". Since they do not, everything he said prior to that is rendered meaningless as tomorrow is not today and next month is definitely not today.

What to think? The last rate cut by the Fed was a close call. Bernanke has said repeatedly that inflation is his main concern. That is what we need to watch first. Growth second. If inflation remains stable or falls then he will act to cut rates should conditions warrant it. If it jumps, Bernanke will be more than happy to let the economy slow even more to stop it. Think Paul Volcker.

Be very careful investing based on Fed statements because once the day they are issued has passed, their relevance pases also.

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