Ben in the Box

Big Ben says help is on the way:

NEW YORK (CNNMoney.com) -- Federal Reserve Chairman Ben Bernanke said in a speech Thursday that the central bank is prepared to continue lowering interest rates in order to help keep the economy on track.

He also reiterated that the Fed does not believe the economy will slip into a recession this year.

"We stand ready to take substantive additional action as needed to support growth and to provide adequate insurance against downside risks," Bernanke said in prepared remarks before the Women in Housing and Finance and Exchequer Club in Washington, D.C.

Now I'll agree that we will not slip into a recession this year, being as how we are probably already in one*. But I think that old Ben has less wiggle-room here than most investors understand, and probably even less than he thinks.

The first limitation is the obvious one: the Fed Funds rate is already at 4.25%. Yes, it can be lowered even more, but it's a far cry from, say, the recession of 2001, when the rate was at 7.5% and was dragged to 1%. Already one of the spark plugs on his moneycopter is fouled.

A second limitation is the fact that the dollar is already in the tank. When today's speech about the possibility of a rate cut was published, the buck spiked down half a point and gold jumped $17 to another new record. And that's just on talk of the possibility. Cutting too far or too fast creates the potential for a rout on the currency markets, something no bank wants to have to deal with.

But the third limitation is the most important one even as it's the least visible, and that's that investors are now trying to outguess the Fed:

To that end, investors are pricing in a 90 percent chance that the Fed will lower rates by a half-point on Jan. 30, according to federal funds futures listed on the Chicago Board of Trade.

Now some of you are saying, "So what, El B? That doesn't mean they'll guess correctly." No, it doesn't. What it does mean is that the Fed, unless it wants to scare the horses, has just been given its number.

You see, if the Fed cuts half a point, no problem. That's what was expected. But let's say they cut 3/4. Then everyone goes, "ooh, stuff must be really wrong for them to cut more than expected," and then the stock market tanks. So let's say they cut 1/4 point, then everyone will scream, "What are they doing? The Fed doesn't understand how bad it is here," and then the stock market tanks. Even then, 5 minutes after this cut the market starts pricing in the next cut.

Basically, all Bernanke can do here is try to adjust expectations; he cannot set them. His credibility*** depends upon him looking like he understands the market, because his rap is that he doesn't and that scares the market. So he must meet their expectations, exactly, whatever they happen to be on that fateful day when 12 Fed Governors meet and pretend to look at the data.

* A remark that would drive the GOP cheerleaders at Newsbusters crazy, if they knew that I existed**. But by their criteria, it is impossible to declare whether you had a recession until 8-11 months after the end of the quarter in which it began, by which time it's probably over. A damned useful metric, that one.

** Which they don't.

*** He's not exactly, as they say, from the Street. This might help. Or not.