Peter, My explanation is simple, as I am also no currency expert. The Fed adding reserves simply allows banks to extend more credit. However, if demand for credit is greater than the supply, even with the added reserves, you get a rising rate as many borrowers bid for the limited pool of cash. It is a supply and demand market like anything else. The Fed is creating huge supply, but the demand to borrow money is larger.
Now we come to the part that is more subjective. The relationship between the big stocks and Fed Funds is, IMHO, quite simple. The final borrowers are not increasing business capacity, because they have too much already. What they are doing is speculating in securities. So, adding reserves has much the same effect as cash flowing into mutual funds. This certainly isn't a 100% correlation, but my guess is most loans find their way into financial speculation of some sort. It may be a hedge fund borrowing at 100 to 1 leverage on a derivative spread position or it may be Merrill Lynch extending credit to customers who want to buy more Amazon.Com. But the financial markets are running on debt right now and the Fed is determined to feed them their pound of flesh.
That is why monetary moves like adding to reserves has little effect when the market heads south. In bear markets, folks don't want to invest in the markets even if they can borrow at low rates.
This puts the Fed in a tough position. If they don't continue to not only feed the monster they created, but feed him more, the market will crash. But, as they feed him more, bond rates go up and the dollar comes under pressure. So far, neither higher bond rates or a dollar decline have been severe enough to force AG's hand. But they will. And, oh, what a happy little crash the market will have then.
MB |
