In our Schaeffer's Media Outtakes series, Bernie Schaeffer dissects the news, using contrarian analysis to provide a unique take on the market.

"December (fed funds) contract fully prices in expectations for FOMC to cut funds rate to 4.25% at December 11 policy meeting and shows roughly 28% odds for rate cut to 4%."
(Dow Jones NewsWire 11/26/07)

"There's no mistaking the deterioration in credit and other risky asset markets since the October FOMC meeting; these constitute tighter financial conditions...the disconnect between Fed rhetoric and market thinking is intensifying this spread widening, and is especially ironic for a Fed that has just gone to great lengths to enhance and improve its communications with the public."
----(Richard Berner of Morgan Stanley as quoted on wsj.com's MarketBeat 11/26/07)

"One key measure of liquidity the rate of the London Interbank Offered Rate, or LIBOR (basically a traded fed-funds rate for the world), over the federal-funds target, was lately at 0.55 percentage point, traded around 5.05%. Compare that to the usual which is a few hundredths of a percentage point above the federal-funds target. 'If that sticks for the balance of the year, which is what futures market it suggests a spread kind of in-line with what we saw at the end of the early 1990s when the S&L crisis was working its way through the system,' says Steve Van Order, chief investment strategist at Calvert Asset Management."
---- (wsj.com MarketBeat 11/26/07)

"'Recession is getting priced in,' said Jan Loeys, economist at JPMorgan, adding that markets went into 'virtual panic mode' last week. 'Pressure is building for central banks to become a lot more active and vocal [this] week if they want to avert a collapse in credit markets.'"
---- (Financial Times "Investors fear new turmoil" 11/25/07)

"The subprime mortgage crisis is poised to get much worse. Next year, interest rates are set to rise -- or 'reset' -- on $362 billion worth of adjustable-rate subprime mortgages, according to data calculated by Bank of America Corp."
---- (The Wall Street Journal front page "Rising Rates to Worsen Subprime Mess" 11/24/07)

"Minutes from a recent Federal Reserve powwow sounded a hawkish note, but Goldman Sachs economists expect the Fed 'to change its mind on the need for further monetary easing.' The biggest threat, they say, isn't the declining stock indexes, 'but the increased risk of damage to the financial system signaled by the sharp downturn in financial-sector stock prices.'"
---- (Barron's "The Trader" 11/26/07)

"Yields on two-year notes are at 'extreme levels, indicating the bond market's perspective that the Fed needs to go to an easing cycle,' said T.J. Marta, a fixed-income strategist in New York at RBC Capital Markets, the investment- banking arm of Canada's biggest lender. 'It's no longer asking politely. It's back to demanding.'''
---- (Bloomberg.com "Treasury 10-Year Yield Is Lowest Since March 2004 on Subprime" 11/26/07)

"Economists say the U.S. economy is slowing significantly, with many forecasting growth in the current quarter at an annual pace of little more than 1%. While the Fed has cut interest rates twice since August, it has hinted at hesitation to go further. One reason is the slumping dollar. Yesterday the dollar fell to its lowest level against the Japanese yen in more than two years, and it is near a record low against the euro. A lower dollar can raise the cost of imports, aggravating inflation. If the Fed lowered rates further, it might encourage investors to dump the dollar in favor of higher-yielding currencies."
---- (The Wall Street Journal front page "Stocks Sink Into Correction as Credit Fears Take Toll" - 11/27/007)

"Analysts expect the two top Federal Reserve officials to use scheduled speeches to acknowledge that the downside risks to growth have increased since its October 31 meeting. However, they are expected to indicate that the Fed reserves judgment as to whether these increased risks will merit an interest rate cut in December. The two officials will almost certainly make it clear that the US central bank is genuinely concerned about the risks to inflation caused by the weak dollar."
---- (Financial Times "Fed sensitive to risk of rate cut" - 11/25/07)

"Battered stock and bond markets are sending an increasingly ominous signal that a U.S. recession could be near. The markets, however, haven't swayed Federal Reserve officials and most private economists from their view that the nation's economy can escape a downturn and get back on a steadier course. The disparity between those two views of the economy -- one growing bleaker, the other remaining sanguine -- stood out starkly last week."
---- (The Wall Street Journal front page "Recession Fears Weigh Heavily On The Markets" 11/26/07)

"A fool too late bewares when all the peril is past."
---- (Elizabeth I (15331603), Queen of England (1558-1603))

Schaeffer's addendum: It takes a lot to shock me when it comes to government officials and their interaction with the financial markets. But "shock" is the only way to describe my reaction to the fact that: 1. The Fed has not implemented additional rate cuts in recent weeks. 2. There is apparently a debate among Fed officials as to whether they will cut rates at their December 11 meeting.

Market interest rates have left the 4% fed funds rate in the dust, with the two-year note yielding less than 3%. The futures market is assigning a reasonable probability that the funds rate will be reduced by % at the next Fed meeting. Libor rates are reflecting a level of tightness in the market reminiscent of the S&L crisis of the early-1990's. Interest rates are set to rise next year on $362 billion in adjustable rate subprime mortgages.

Yet we are led to believe that, amidst all the financial panic reflected in the fixed income market, the Fed is carefully weighing the "balance" between the risk of an imploding economy and some nebulous concerns about the dollar and inflation. Memo to Bernanke: The level of the dollar already reflects the panic-level rates in the money market as opposed to your artificial funds rate. Dollar investors are far more concerned about an imploding US economy than about you cutting your funds rate. And the risk to the economy is not inflation but deflation.

My pick for the most mind-boggling newspaper headline of the year? The FT's "Fed sensitive to risk of rate cut". (Not "Fed sensitive to risk to economy", or "Fed sensitive to risk of deflation," or "Fed sensitive to risk of runaway foreclosures.")

Mr. Bernanke, you no longer have the option of "reserving judgment" on cutting rates. Mr. Market made that decision for you weeks ago, and should you choose to continue to ignore it you may well be making one of the gravest policy errors of all time.

Addendum to my addendum: To what has the Fed responded without fail with rate cuts over the years? Implosions in the shares of the large, "too big to fail" money center banks. So here's a fearless forecast. Should Citigroup shares begin to regularly close below the $30 level, look for that rate cut, perhaps even before the appointed date in December.

Copyright Schaeffer's Investment Research http://www.schaeffersresearch.com

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