Friday, August 17, 2007

Today's Markets

OK -- the Federal Reserve lowered the discount rate by 50 basis points. Let's review exactly what that means.

US banks use a fractional reserve system. All this means is a bank much have x% of its total assets on hand at any given time. However, in a banks usual business affairs their reserves may dip below this percentage amount. When this happens, banks must borrow short-term money from somewhere. Usually, they go to other banks. The interest rate banks charge each other is the Federal Funds rate. In addition, a bank can go directly to the Federal Reserve and borrow money. The Fed will charge the bank the discount rate. Going to the Federal Reserve to borrow money is a last resort and is usually considered a sign of weakness. Therefore, lowering the Discount rate is largely a symbolic gesture because it isn't used nearly as much as the Federal Funds rate.

However, the Fed's move today signals it is paying close attention to the markets and the economy. Here is the key phrase from today's announcement: "the Federal Open Market Committee judges that the downside risks to growth have increased appreciably. The Fed is saying the chances of an economic slowdown are increasing. While they are not prepared to cut the more important Federal Funds rate, they are paying attention and are prepared to act if necessary.

Here's how the market reacted. It rallied right at the open, dropped a bit then slowed moved up for the rest of the day. The market was thinking about selling off at the end but ran out of time.

Here's the chart from the whole week. Notice that Thursday's dip formed a nice head and shoulders formation, which is usually a sign of a reversal.

Here's a 10-day chart. Notice we dipped below the triangle formation of the preceding 7-10 days, but rose above it on today's rate cut.

Here's the daily chart, which indicates we're not out of the woods because

1.) The SPYs are clearly in a downtrend. Today's action started at resistance but closed lower bringing today's candle clearly within the range.

2.) The 10, 20 and 50 day SMAs are all moving lower. This means there is weekly and monthly bearish pressure on the index.

3.) The shorter SMAs are below the longer SMAs

4.) The moving averages are acting like upside resistance. Today's action started at the 200 day SMA but closed lower. However, today's close was right on top of the 10 day SMA. That could be the sign of some strengthening in the market.