Rush To Safety

As you no doubt heard, last Friday morning the Federal Reserve reduced its Discount Rate and took some other measures to encourage the credit markets. The Discount Rate is not near as important as the Federal Funds rate, which was left unchanged. It was, in our view, a largely symbolic act designed to send a message that the Fed is not asleep at the wheel. If so, it had the desired effect - for about a half-hour. That was how long it took Friday's opening rally to top out.

Today brought another surprise. The 3-month Treasury Bill yield is a widely used benchmark for short-term loans, and it also serves as a kind of proxy for cash-equivalent assets. This time last week, it stood at 4.7%. Today the same T-Bills traded for a yield as low as 2.5%. This is an unprecedented drop, far exceeding what happened even in previous market panics such as October 1987. A fall in the T-Bill rate means that investors are willing to pay almost any price for safety. Please note, most of this decline happened today, after the Fed supposedly rescued the markets. Clearly some people are not yet convinced.

We were actually quite surprised when the Fed acted on Friday; our feeling was that Bernanke would let Wall Street fend for itself rather than risk inflation and possibly damage his own credibility. Now it appears that the main thing the rate cut accomplished was to demonstrate that the Fed is just as clueless as everyone else. The policy statement from the last Fed meeting on August 7 is now meaningless, and no one knows what kind of policy will come out of the next meeting on September 18. This creates a situation of enormous uncertainty. As a result, markets will likely remain very volatile for the new few weeks.

Sector action remains choppy. Financials, consumer discretionary, materials and real estate remain the weakest sectors, but other than T-Bills nothing is particularly strong right now.