Fed Puts Markets on Notice:Possible Discontinuation of 24/7 Happy Hour

“Hitler will send no warning- so always carry your gas mask” – British Ministry of Home Security poster circa the Sitzkrieg* (October 1939-April 1940)

The economy is already wearing an over sized Fed tailored suit and now the market is worried that the Fed might “taper” that suit.

Here is what the Fed has already thrown on for size:

Purchases of mortgage backed securities (MBS’s) and U.S. Treasuries (Treasuries)
QE1 $600+ Billion
QE2 $600 Billion
QE3 $480 Billion
QE3 + (infinity)$1 trillion+ annualized
QE infinity “tapered” to $65 billion per month =$780 billion annualized

As you can see, even if the Fed were to cut back their purchases they would still be buying a monumental amount of MBS’s and Treasuries as their war on the US dollar continues in a vain attempt to keep interest rate low.

When the Fed first launched QE1 and subsequent iterations, gold and silver soared in anticipation of future price inflation. It took three rounds of QE before the price of stocks and real estate finally responded. Since price inflation has remained nascent in spite of a couple trillion worth of QE, gold and silver recently nose dived (you can blame manipulation on the price declines but the markets would have snapped back if they didn’t believe the “look there is not inflation” narrative, but then how to explain the surge in the purchase of physical and gold and silver-I digress, gold and silver manipulation is not the subject of this post – see GATA for more on that topic)

One point is very clear- if you were worried about inflation when the Fed launched an unprecedented $600 billion QE program, you shouldn’t be any less concerned when the Fed after blowing over $2 trillion threatens to “taper” QE to just seven hundred or so billion a year. The “QE worked and there is no inflation” victory lap is a bit premature because there is no Fed exit.

If the Fed slows down bond purchases, not to mention stops them altogether, bond yields will increase, borrowing costs for home purchasers and the debt laden U.S. will increase and the stock market will most likely “correct” or crash. Notice what has happened to yields since the taper talk started – they are now at 14 month highs and that’s from just talk. The stock market and real estate market are still rolling along, but for how long?

If Fed actually tapered and interest rates rose and the stock market fell, the Fed would probably immediately reverse course and increase the size of QE -i.e open the bar back up 24/7 and start paying people to drink there.

The beneficiaries of Fed policy – the U.S. Government, too big to fail banks, the stock and real estate markets – are so used to the economy wearing such a big suit bloated with QE stimulus, they’d freeze to death without it. Axel Merk calls the seeming permanence of QE the “new normal”.

The first round of QE was extraordinary measure in 2008, but now it’s a permanent feature of the sluggish U.S. economy.

Stop Making Sense?

The Fed knows that things stop making sense when they stray too far from normal. The novelty of QE has worn off and the Fed is aware that if they keep it up too long the novelty becomes a joke and confidence in the dollar will be lost, so they talk taper and act like they are not going to wear the QE suit forever. But they know the markets now demand it and are dependent on it. Thus the Fed’s No Exit dilemma. At some point the Fed will either print one dollar too many and confidence will be lost, or they will print one less dollar and support for the economy will vanish.

The resolution of the Fed’s No Exit dilemma will come without warning, so have your gas masks ready at all times.

The road does not go on forever.

*the early phase of World War II when war had been declared and no real battles ensued for months, luring some into a false sense of security that the war wouldn’t be that bad after all.