Treacherous Market Conditions
Tuesday, June 03, 2014
Does the pace of tapering really matter? Will it have a material impact on valuations or the aggregate economy if the Fed is buying $65, $45 or $25 billion of assets in month X, Y, and Z respectively? FOMC members want markets to believe that they are “data dependent”, but such verbiage could be a ‘slight-of-hand-trick’; espoused so that too much focus is not paid to the fact that the QE program is ending. This might be the reason that markets not reacted to the catalyst(s) to pare risk or why they have been slow to act. Despite Fed rhetoric, investors must realize that the hurdle to deviate from its $10 billion per meeting pace has always been enormous. The market’s unremitting focus on every adjective and word uttered by the FOMC is inane, simply because the Fed is on a steady course for the next 6 months. This is a clear example that the FOMC has become too visible and too involved in financial markets. The ECB recognized that there are negative consequences to such market interference. Draghi stated that he could envision fewer ECB meetings, because he felt that their frequency leaves the market expecting action too often.
The Fed’s chronic desire for slack-less growth has stair-stepped official rates to zero over the last few decades, has made (unconventional) accommodative measures
necessary, and has resulted in a depleted arsenal. Hence, the FOMC is at a critical juncture; and FOMC members have only themselves to blame for being in such a position. The Fed’s ability to reverse any new ebb in economic activity in the future is now severely limited, increasing the importance that current Fed initiatives succeed. This is likely the justification for QE-infinity. Today, the Fed has little choice but to stay overly-accommodative even if the economy heals satisfactorily. With this in mind, most expect the economy to heal and are preparing for the inflation battle. However, such an outcome is not assured and big problems will arise should the economy sputter.
Boom to Bust and Back Again
Prior to 2008 (under Greenspan), the Fed believed that the financial sector was mostly self-stabilizing and that bubbles were un-identifiable. The FOMC believed that, if necessary, they had the ability to ‘clean up’ after excesses (i.e., bubbles popped). Greenspan’s Fed believed that it had the adequate tools for ‘after-the-fact’ crisis management; which it believed was always more appealing than making the politically difficult decisions that would have been necessary to prevent financial crises or imbalances in the first place. After the 2008 crisis, policymakers have tried to end this mindset by becoming more proactive in trying to prevent financial crises. Though well-intentioned, this new