Maestro on Auto Pilot

Earlier in the year, I penned a post, ‘The Greenspan Put’, indicating that I thought Greenspan would not raise rates aggressively because he didn’t want to slow the economy and put his reputation as the "Maestro" at risk. 

I couldn’t have been more wrong.  The "pressures on inflation" wording from the Fed statement indicates that the Fed is not blind to the risks of rising prices.  I think the Fed will continue to tighten rates until the economy slows.   

The Fed Futures Forwardation indicates that the market thinks Fed funds will be 4% by year end.  Before reading the revised Fed statement yesterday, I would have thought the market was smoking something.  Now I think its pretty much a done deal.   

Source: BullandBearwise.com

I think a 4% Fed rate will almost guarantee a flat yield curve.  The 10 year bond currently yields 4.6% and I think that yield will go down, not up, if the Fed keeps rising rates. The economic growth has been built on the back of increasing housing prices and higher levels of consumer debt.  I don’t think the economy is strong enough to handle higher rates.  A slowdown in housing will slow the economy in a quarter or two.

I think the Fed is finally aware of the asset bubbles in housing and corporate bonds.  Just like the Fed targeted the bubble in the NASDAQ in 1999, I think the Fed is now targeting the bubble in housing.   And unfortunately, that means the Fed will take down everything else with it – GM, C, Banks and Thrifts, and the all mighty Housing Stocks.   

Apparently, Greenspan doesn’t care about his legacy as the "Maestro" as much as I thought.  He will leave office in 2006.  And if he continues raising rates at this "measured" pace he will be leaving at the beginning of a Fed induced recession.