Life is stranger than fiction.  Saudi Arabia says attacks were “unquestionably” sponsored by Iran; an attack that caught all flat footed and was thought impossible.  As noted the other day, this is a massive escalation, perhaps on the same level as the Iraqi invasion of Kuwait or the Iranian/Iraqi war of the 1980s.

How will this unfold?  The complacency is incredible.

Then there is the funding/liquidity crisis which caused the overnight rate to surge to 10% versus the targeted 2.25% rate.  Yes the Federal Reserve diffused the liquidity crisis by acting as the lender of last resort but the operative question is why did it occur?  As widely noted this is first intervention by the Federal Reserve since September 2008.

Some state it the result of a broken plumbing system that has decimated trading desks, the result of regulatory fiat.  Others say it was demand for funds because of tax payments and Treasury auctions.  Others are beginning to suggest it was the result of six days of intense volatility in the financial markets that caused an outsized demand for funds.

As noted earlier, last week the difference between momentum and value had its biggest change in over 10 years where shorts and longs moved in the opposite direction than what was expected.  Treasury yields surged and then on Monday the largest daily increase in the price of oil in history occurred with CTAs holding a record number of shorts on oil and natural gas.

This brings us to the outcome of the Fed meeting.  As widely expected, Federal Reserve policy makers lowered their main interest rate by 0.25% for a second time this year but were split over the need for further easing. The FOMC stated it is caught between uncertainty over trade and a domestic economy that is holding up well and could be defined as “solid.”

The targeted range is now 1.75%-2.0%.  The Committee stated inflation pressures remain muted and the labor market as “strong” with “solid” job gains.  Consumer spending is “rising at a strong pace.”  In other words the rate cut was for global not domestic concerns.

Fed officials also lower the interest rate paid on excess reserve by 30 basis points, a move that may help stem the perceived liquidity crisis, reducing the incentive for banks to park money at the central bank instead lend in other short term markets such as fed funds.  As little as three days ago this adjustment was not expected.

The Chairman dismissed the actions of the last two days but did state the Fed will continue to provide reserves so that frequent operations are not required.

Initially equities, led by the technologies, sold off on the news as the statement was skewed as hawkish.  Moreover the Committee did not send a clear message about what it would do in the future.  By the close, equities were essentially unchanged.  Treasuries reversed gains and also closed almost unchanged.

What will happen today?

Last night the foreign markets were up.  London was up 0.60%, Paris up 0.41% and Frankfurt up 0.17%.  China was up 0.46%,  Japan up 0.38%  and Hang Sang down 1.07%.

The Dow should open nominally lower.  Oil is up about 2% as doubts arise as to whether or not Saudi Arabia will be able to restore capacity as quickly as projected.  The Fed is conducting its third consecutive repo auction today in an attempt to bring the overnight rate back to 1.75%-2.0%.  The NY Fed will announce today’s rate at 9:00.    The 10-year is up 6/32 to yield 1.78%.


The views expressed herein are those of Kent Engelke and do not necessarily reflect those of Capitol Securities Management. Any opinions expressed are statements of judgment on this date and are subject to certain risks and uncertainties which could cause actual results to differ materially from those currently anticipated or projected. Any future dividends, interest, yields and event dates listed may be subject to change. An investor cannot invest in an index, and its returns are not indicative of the performance of any specific investment. Past performance is not indicative of future results. This material is being provided for informational purposes only. Any information should not be deemed a recommendation to buy, hold or sell any security. Certain information has been obtained from third-party sources we consider reliable, but we do not guarantee that such information is accurate or complete. This report is not a complete description of the securities, markets, or developments referred to in this material and does not include all available data necessary for making an investment decision. Prior to making an investment decision, please consult with your financial advisor about your individual situation. Investing involves risk and you may incur a profit or loss regardless of strategy selected. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. If you would like to unsubscribe from this e-mail distribution, please reply to this e-mail and indicate that you wish to unsubscribe in your response.