The bond market fell, the gold market rose to new highs, and currencies rose. These markets quickly gave their opinion of the Fed's actions: this is an inflationary bungle of monumental proportions.
These markets are now stabilizing, and waiting for the next phase in their move to confirm the error of the Fed's actions.
With money (MZM) growing at better than 10% per year, mostly fueled by loan growth, this action will only encourage lending by banks, leading to further money supply growth, more inflation, and higher long term interest rates.
Prudent money managers are now extending the maturity of their liabilities, locking in long term financing at these levels.
BONDS
Let's look at the weekly chart for 30 Yr. US Bond Futures.
Notice the recent price action. After testing the old highs for the contract, the market began to fall in preparation for the Fed meeting.
Once the Fed made the decision to lower rates, the decline accelerated, and only this week has stabilized, four points lower.
It looks like there will be a steady decline back down to the 104 level, where we'll find temporary support.
GOLD
The gold market also moved well in advance of the Fed's actions.
Notice prices were at the $715 per ounce level before Fed action, and immediately punched through resistence, making new highs near $750 per ounce.
Record highs are not too far above us, now, and this market will certainly test those levels.
FED FUNDS
The last time gold prices were at these levels, the Fed was still raising short term interest rates, trying to slow money growth.
Note the date on which gold prices peaked and compare it to the date on which the Fed stopped raising rates.
Gold prices peaked in May of 2006 and the Fed stopped raising rates a few months later.
This action says to most participants that inflation - in the form of gold prices - is a primary concern of the Fed.
Will the recent spike in gold prices cause the Fed to reverse itself again and start raising short term rates again?
If so, what will this do to the US economy?
This is the nightmare scenario that's talked about in financial strategy sessions throughout the world.
TACTICS
Extend the maturity of liabilities to five years. Lock in rates at these levels, because inflation will raise long term interest rates.
Make no new long term loans for at least 6 months.
Retain all loan servicing.
Continue money market arbitrage.
STRATEGY
Senior managers must be warned of the potential for future inflation and increases in long term rates.
Senior managers must warn the Board of Directors of the potential dangers of continued money growth.
The Asset/Liability committee must review its plans for an extended period of instability in the long term credit markets.
Hedging programs must be prepared to allow the institution to take advantage of temporary spikes in bond prices and sell futures in anticipation of bond issuance.
Spreads must be widened on all loan transactions. Add fifty basis points today, and consider adding another fifty as bonds trade lower.
