• February 19, 2010 Market Commentary By Art Cashin

Cashin’s Comments

On this day in 1872, "society" in America took a great leap forward. It was natural, of course. This year was the fulcrum of America's "Gilded Age". Ward McAllister was in the process of inventing "the 400", a crème de la crème of American society. (The number was 400 because that was the capacity of the Grand Ballroom at the
mansion of Mrs. Astor, McAllister's patron.)

Now, if you're going to be looking down your Lorgnette at the Irish serving girl
between courses and find something stuck in your teeth - - what shall you do. Fear
Not! Necessity is truly the mother of invention. Ballrooms filled with the delicate but
dentally challenged would soon get help.

Enter Messrs. Silas Nobel and James P. Cooley. These paragons of good taste arrived
at the patent office on this day and got a patent on - - the toothpick.

To celebrate, stop by the "Hoi Polloi Lounge" and try to think of something common
that you could standardize; patent; and make a fortune on. But try not to gum things
up. Markets were not particularly picky Thursday. Stocks floated higher, once again in
reaction to moves in the dollar.

Stocks Sleepwalk Into Resistance As Gold Stalls – Stocks and oil moved higher
yesterday as the dollar (DXY) seemed to stall around 80.75 for the third time in a
couple of weeks. The reaction was especially evident shortly after 2:00 when the DXY
accelerated its fade and stocks spiked.

Gold temporarily dropped out of the reverse dollar troika. Traders attributed the stall
by the yellow metal to comments from the IMF that it was contemplating a large sale
from its bullion reserves.

The low volume levitation in stocks took the S&P right up to the upper end of the
1103/1108 resistance band that we wrote about in Thursday’s Comments. The intraday
high of 1108 was right at the 50 day moving average.

Traders were fascinated by the fact that the dollar influence clearly outweighed some
“less than glowing” data and headlines. From Initial Claims through Iranian
warheads, the stock bulls seemed unfazed.

The continuing lackluster volume on up days remains a concern. We will know a
good deal more in coming days as we see how the averages address the resistance.
A Near Plenary Session Of The Friends Of Fermentation Gets A Message From
The Fed – The FoF was musing and marinating ice cubes, post close, when
conversation was suddenly interrupted. Blackberries and Iphones lit up with the flash
that the Fed had raised the Discount Rate by a quarter point.

The immediate response was a scramble to establish that it was the Discount Rate
only. The second move was to gauge market reaction. Once they were sure that it was
only the Discount, or “emergency”, rate the muted market response was understandable.

The buzz about the rate hike drew questions from some none Wall Street types on the periphery. A quick lesson in central bank money mechanics ensued. It was explained that the Discount Rate only related to the Discount Window. It was further explained that the Discount Window was where banks came when they couldn’t borrow from other banks. The Discount Rate was traditionally higher than the Fed Funds rate and borrowing at the window usually carried a stigma since it indicated that other banks saw you as a weakened credit. During the banking crisis, the Fed took pains to eliminate both the stigma and the premium. So, to some degree, the hike in the Discount Rate was a signal that the crisis phase is over and banking was returning to “normal”.

The FoF then discussed the timing of the move. The general feel was that it might be an attempt to keep the bond vigilantes at bay in the wake of the surprise spike in the PPI. It was felt that a Discount Rate hike was in the Fed’s pocket since Bernanke said in his February 10th testimony when he said the Discount Rate would be hiked “before long”. The FoF felt the PPI, and similar inflationary data in Britain and elsewhere, prompted the Fed to announce the already agreed upon rate hike.

The thinking at the FoF is reflected to large degree by an essay on the website “Seeking Alpha” from someone writing under the pseudonym of The Inflation Trader:

I suppose that we ought to deal with the last things, first. Yesterday afternoon, the Federal Reserve hiked the discount rate to 0.75%, prompting a further selloff in Treasuries after what had already been a less-than-stellar day (TYH0 closed down 15/32nds, and another 5 ticks after the announcement). What is the Fed up to?

The discount rate increase has no practical, economic significance. Although use of the discount rate window no longer carries quite the stigma it once did (partly because the Fed, during the crisis, tried hard to encourage banks to use it), it is still a fairly unattractive source of funds when uncollateralized 3-month rates (LIBOR) are lower.

The hike in the rate also has no signaling significance, since the FOMC can be (and has been) very vocal about what their plans are for removal of accommodation: to wit, they have no plans to remove it any time soon.

The Fed itself confirmed these two points in the press release announcing the change, which said in part The modifications are not expected to lead to tighter financial conditions for households and businesses and do not signal any change in the outlook for the economy or for monetary policy.
It is hard to get clearer than that.

The initial reaction in the markets has become a bit more muted as folks come to see the move as more symbolic than strategic. The discussion of the timing continues. Our friend, David Kotok, hit squarely on the paradoxes in the move in his opening paragraph on the topic:

Let’s see. The Fed hiked a rate even though it wasn’t the policy rate. The Fed shortened a term even though it wasn’t the “normal” term. The Fed announced it as a surprise even though they have been saying they want to be transparent and prepare markets for changes in advance.
And the Fed speakers then spent effort trying to explain why a discount rate hike at an inter-meeting move with a reduction in term is not a tightening action.

As always, David is spot on in the anomalies in the timing and process.

Cocktail Napkin Charting – As previously noted, the low volume levitation took the S&P into the initial resistance at
1103/1108 (anchored on the 50 DMA). Today’s Expiration may offer an opportunity to clarify the napkins even more.

For today, the napkins see first support at 1095/1098 with backup at 1087/1092. Resistance looks like 1106/1109 and
then 1113/1118.

Consensus – Expiration could bring a surprise or two. If the 8:30 CPI looks inflationary, it will prompt a lot more
discussion of the rate hike. Stay very nimble.

Trivia Corner
Answer - The common four word phrase that only has "o" for a vowel is - "From Top to Bottom."
Today's Question - You have a piece of wood 13 inches long. If you marked it at 4 points: 1 inch, 2 inch, 6 inch and 10 inch,
you could measure any number of whole inches from 1 to 13. If the piece of wood is 36 inches long, what is the smallest
number of marks needed to measure any whole inch from 1 to 36 (and where do you put the marks)?

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