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Fed’s Next Move

As discussed in a previous article (Don’t Fight the Fed…) the Federal Reserve is all powerful when it comes to determining the imminent stock market direction [because of their manipulation of interest rates].

What’s worth considering is what happens when the Fed runs its course.  When interest rates have been kept artificially low for too long- then there’s nothing left to cut when the next recession rears its ugly head. 

Such a scenario may be brewing now.  The Fed has artificially kept interest rates low for over five years and continues schemes to inflate the currency by injecting Quantitative Easing (QE).

The problem is that QE is now in its third rendition and the Fed’s balance sheet has expanded to over $3 trillion dollars.  The Fed is purchasing about 80% of US debt.  QE may have reached a state of diminishing returns- the only thing that’s inflating is the stock market and housing prices.

Growth is anemic.  GDP struggles to exceed 2%.  Corporate profits are up but the rate of growth has slowed.  Top line sales are mostly flat.  So what’s the Fed achieving by dumping $85 billion per month into the economy?  Not much:   2013 combined money printing of $1.66 trillion (QE3 + Deficit) has resulted in GDP growth of $386 billion (2.3%).  Would you “invest” $4 to make $1?

The “experts” clearly would, as long as it’s not their personal money.  Pundits are now predicting that the Fed won’t start easing QE until at least March 2014.  These are the same prognosticators that claimed the Fed would start tapering in October 2013.  Many are claiming that the newly appointed chair Janet Yellen is so loose with money that she won’t taper until 2015 or beyond.

Easing or tapering of QE is a serious matter.  At some point it has to come to an end, but there lies the conundrum.  If QE is cut, equity markets will pull back at the same time that bonds decline in value.  Clearly a lose-lose.  Commodities probably won’t fare any better (even precious metals- remember that gold plunged in the Fall of 2008 just like all other asset classes).

The question on my mind is why is Chairman Bernanke departing before the ship is back on course?  His predecessor Alan Greenspan served 20 years and didn’t retire until the age of 80. [Conveniently just before the housing bubble burst.]  Bernanke is only 60, apparently in good health.  We’re told he’s a scholar of the Great Depression and his QE policies have been implemented to avoid another depression.  So why leave after only 8 years when clearly the economy hasn’t recovered?

Perhaps Bernanke is following the lead of Greenspan and plans to exit before the equity bubble bursts. 

Or perhaps his role is to play the fall guy and cut QE before he departs, so the markets will correct and Yellen can start with a clean slate. 

Alternatively, maybe Yellen’s role is to play the tough guy.  Let Yellen cut QE at the start of her administration- better for markets to crash early in her tenure and hope thing work out in four years when she’s up for reappointment.  She can always blame it on Bernanke.

What will happen?  I have no idea.  We live in interesting times.  The prudent investor is patient.  He waits to enter a market when there is a clear sign that a trend is emerging.

By the way, I don’t feel embarrassed admitting I have no idea when the Fed will end QE, or what direction the market will take tomorrow.  I’m in good company.  Recently Alan Greenspan admitted that he was “surprised” that Fed models didn’t predict the housing bubble.  Isn’t that reassuring?