Don’t fight the Fed. It’s an important piece of Wall Street wisdom built on the often-repeated power of changes in the Federal Reserve’s policies on interest rates and the money supply to overwhelm all other financial market trends. When interest rates are headed down and the money supply is headed up,  most of the time, stocks will head up too.

Not always, of course, since the Fed itself can get overwhelmed by a global financial crisis here or a euro debt crisis there that can lead to a situation where the real economy doesn’t respond to the Fed’s monetary prodding.

But the saying is true frequently enough so that aligning your investment strategy with Federal Reserve policy makes sense most of the time.

So what about when it isn’t just the Federal Reserve that’s lowering interest rates and pumping money into U.S. economy, but the European Central Bank pursuing the same course in Europe, and the Banco Central do Brasil in Brazil, and, just beginning but accelerating, the People’s Bank of China in China?

Is this flood of cash enough, by itself, to push stocks higher in 2012—no matter what the real global economy is doing? Traders and investors have started 2012 by answering that question with an emphatic Yes. January’s rally in U.S., European, and emerging market stocks is based on a belief that the huge wave of cash that the world’s central banks have unleashed—or are about to unleash—on global economies will send stock markets higher and set economies to growing faster.

Let me give you two reasons why the global version of Don’t fight the Fed won’t work out quite as well as the current optimism suggests this time around. Read more

Maybe you think the “solutions” to the euro debt crisis being pursued by German Chancellor Angela Merkel and European Central Bank President Mario Draghi are totally wrong. Maybe you can’t imagine that these two leaders are seriously proposing to condemn the EuroZone to a year of recession followed by more chaos and, at best, slow growth again in 2013 and 2014. Maybe you think that Merkel and Draghi will cave in under pressure rather than see Greece default and rather than watch demonstrations sweep Madrid and Rome. Maybe you can’t imagine that EuroZone leaders will cling to a “fix” that has been so thoroughly rejected by bond markets.

Okay, but I think it’s time to take Merkel and Draghi at their word. They are wedded to a plan that consists of austerity, pain, and recession—and years of it. And on the evidence there is a good chance that Merkel and Draghi can actually make their plan stick politically. The Germans are the biggest and strongest economy in the EuroZone and the German government and the Bundesbank control the cash needed for any solution.

So let’s say that Merkel and Draghi are able to execute their plan—against all opposition and against whatever personal advice you or I would offer. What then does the EuroZone and the global economy look like?

Let me sketch in the most likely scenario here. And then I’ll suggest its effects on the financial markets. Read more

Federal Reserve does nothing and the markets aren’t happy

I guess financial markets were looking for the Federal Reserve to dump billions into bonds and stocks today.

At least that’s what I conclude from the drop in stock prices this afternoon after the Federal Reserve’s Open Market Committee gave no indication that it was about to open the floodgates.

I don’t think the markets had any reason to believe that the Fed would decide to unleash a wave of bond buying on the markets. But the lack of a reason has never stopped markets from dreaming. And right now most investors—I know I feel this—would like someone to do something to stop the pain.

The statement from the Open Market Committee actually sounded relatively optimistic. (Granted that when most voices are calling for the end of the world, it doesn’t take much to sound optimistic.) “Information received since the Federal Open Market Committee met in November suggests that the economy has been expanding moderately, notwithstanding some apparent slowing in global growth,” the Fed said. “The Committee continues to expect a moderate pace of economic growth over coming quarters”

Given that view, the Federal Reserve decided to stay on the current course. The Fed will continue its current policy of buying longer maturity Treasuries when short-term Treasuries in its portfolio mature. Read more

Stocks soar as world’s central banks move to support big banks just hours after S&P downgraded them

Put that in your new ratings model and smoke it, Standard & Poor’s.

Hours after Standard & Poor’s downgraded 16 of the world’s biggest banks—largely because the company’s new model for awarding credit ratings decided that governments were less likely to support their big banks—six of the world’s central banks, led by the U.S. Federal Reserve, came to the support of the world’s big banks.

In a coordinated move the central banks lowered the cost of emergency dollar funding by 0.5 percentage points. By lowering the cost of dollar funding from the central banks, the move will make it easier for stressed European banks to fund their dollar-denominated activities. The cost to European banks to fund in dollars had climbed to the highest level in three years.

On the news of the central bank move, the German DAX Index was up 4.9%, and the U.S. Dow Industrial Average had climbed by 3.7% and the Standard & Poor’s 500 by 3.6% as of 11:45 a.m. New York time.

Shares of the banks that S&P downgraded yesterday are performing even better. Read more

Lack of inflation in October leaves Fed free to act

Consumer inflation declined in the United States in October by 0.1%. That was the first drop since June. The core inflation number, which excludes food and energy, climbed 0.1% in October.

I wouldn’t make too much of this number—for reasons that I’ll explain later—but it is good news. A decline in inflation, for whatever reason, gives consumers a bit more spending power going into the holiday shopping season.

The absence of inflation also means that the Federal Reserve can concentrate on stimulating the economy—QE3 anyone?–without the constraints imposed by worries about letting inflation get out of control. And there’s certainly nothing in these numbers to endanger the Fed’s pledge to keep its benchmark interest rate near 0% until mid 2013.

You don’t have to look far for the reason for the October drop in inflation. Energy prices fell 2% in October from September. That’s largely an artifact of the way that the Bureau of Labor Statistics conducts its price surveys. The government statisticians examine consumer prices during a single week in the month. In September that week happened to correspond to a small surge in gas prices—the major reason that inflation rose by 0.3% in September from August. In October the sample week saw prices considerably lower than those in that week in September.

I don’t think, therefore, that you can use the October drop to conclude that inflation is falling in the long run. But I think it is safe to say that inflation isn’t about to run out of control—and that deflation isn’t a danger either at the moment.

What’s called headline inflation climbed by 3.5% from October 2010. But core inflation, the number the Federal Reserve watches, rose at just a 2.1% rate from October 2010. The Fed’s inflation target is 2% or less.