Got Gas?

January 5, 2001
Marc Dupee

Stock index futures ran out of gas as cross-currents rippled through markets,
but left them decidedly negative and wondering whether the Federal Reserve’s
surprise interest rate cut this week was too little too late.Â

The high price of natural gas played a not-so-indirect
role in the stock market’s uncertainty. Concerns surfaced today that such major
financial institutions as Bank of America, Chase, Citigroup, and JP Morgan, may
all be vulnerable to California utilities companies who are in risk of
defaulting on lines of credit to the banks. Both California Edison and Pacific
Gas and Electric are clamoring to regulators for permission to pass along higher
energy and electric costs to customers as wholesale prices have soared. New laws
prohibit new power plants from burning any fuel other than natural gas in
California. Natural gas prices have nearly tripled in one year, making nat gas
futures the commodity of 2000.Â

The possibility of a major financial default had a
familiar feel in that the last time the Federal Reserve cut interest rates
between its regularly scheduled sessions was in October 1998 during the Asian
crises. The Fed twice authorized “intersession” cuts. It cut the
federal funds rate 50 basis points Wednesday shortly after 1 PM ET and the
discount rate by 25. Thursday evening, the Fed again made an intersession
discount rate cut.Â

The nearly unprecedented back-to-back cuts (even if just
the discount rate) left the
impression that banks may be in trouble and may need the additional liquidity to
maintain minimum reserve requirement or manage loan defaults. Not having adequate reserves becomes a problem when banks are
in trouble, and escalated ideas that any crises, either in selected
sectors–such as utilities and financials–or in the broad economy may be worse
than the Fed is yet informing us of.Â

Last night’s cut at the Feds discount window to 5.5%, highlights the perception
that the Fed may be nearly panicked about the state of the economy and could
further cut rates at any time. Here are some factors to consider in your evaluation of what the Fed’s likely
path on (the federal funds) interest rates is likely to be in the current
“loosening cycle.”Â

While today’s employment figures came in as expected, Tony
Crescenzi details in his Crescenzi
On T-Bond Futures factors such as a GDP proxy contained in the report that fell a large 0.7% in
December. Tony says this “suggests GDP is slowing to a crawl and might in fact be poised to
contract (if it hasn’t already).” He says a 25-basis-point cut “looks assured”
with today’s report.

In yesterday’s Market Flash I pointed out that the federal funds futures
contract, the most accurate predictor of Federal Reserve rate moves, was pricing
in as much as an 84% chance that the
Fed will cut an additional 50 basis points at its January meeting. Today the
February contract
(
FFG1 |
Quote |
Chart |
News |
PowerRating) is pricing in a 98% chance of a 50-basis-point cut by its January meeting. To learn
how to make this simple calculation for yourself, see Loren Fleckenstein’s article
titled Forecasting
The Fed With Federal Funds Futures.Â

The January federal funds futures
(
FFF1 |
Quote |
Chart |
News |
PowerRating) is showing a 40% chance of a
25-basis-point intercession cut and a 20% chance of a 50-basis-point
intersession cut.Â

In a new feature on our sister site, you will be able to
look at how Tony Crescenzi traded the volatility surrounding the Fed’s surprise
move this week in the 5-year futures
(
FVH1 |
Quote |
Chart |
News |
PowerRating),as well as learn about how to approach a low-risk trade in the
federal funds futures. See this Saturday’s Trade
Of The Week featuring Crescenzi.

Currencies acted to confirm that the US economy will
under perform in comparison to European economies. Euro FX futures
(
ECH1 |
Quote |
Chart |
News |
PowerRating),

Cocoa
(
CCH1 |
Quote |
Chart |
News |
PowerRating) gapped open and out of aÂ six-day flag
pattern. One of the reasons cited for cocoa’s rally was a stronger euro. Cocoa also trades in London and is
often priced in pounds sterling. The euro FX futures
(
ECH1 |
Quote |
Chart |
News |
PowerRating)
have risen twice as fast as British pounds on a percentage bases, up 15% versus 7%, respectively. This makes
cocoa purchases in euros relatively cheaper and
implies European cocoa users are swooping in to get relatively cheaper beans for their
chocolate production. Lower crop yields are also being forecast in Nigeria, a
secondary producer.

The freeze that occurred just days ago in Florida’s citrus
belt is now surfacing as a concern in orange juice. March orange
juice
(
OJH1 |
Quote |
Chart |
News |
PowerRating) has shot up as much as 6.69% to close on its 813 high, a
gain of 45.

Got Gas?

BUY THE FEAR, SELL THE GREED

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