Tapering IS Tightening

The Fed’s RecovQEry is in Jeopardy

In June this year we noted the Fed is trapped. They know they have to stop quantitative easing (QE) as their balance sheet is already too large to unwind, the real estate and stock markets are already too dependent on QE and if they continue price inflation will eventually result. The Federal Reserve Chairman, Ben Bernanke also knows, however, that if rates go higher in this weak economy the markets and economy will crash.

The Fed faces a Hobson’s choice and its members are constantly vacillating in their meetings and public statements whether to start to pull the plug on QE or continue it in a vain effort to stimulate the economy. This internal, seemingly eternal debate has led to nothing but incessant taper talk from Ben Bernanke and the Fed governors. When the markets get complacent that the Fed will continue QE for ever, they start to talk taper. When they do, rates rise and the Fed starts making hints about keeping QE going just a little while longer.

Taper, not Tighten – The RecovQEry without QE?

Rather than allowing rates to rise and the economy to restructure, the Fed is desperate to keep the cheap money flowing. They refuse to make the hard choice between continuing QE and taking their chances with hyperinflation and a dollar collapse or shutting down the program and allowing interest rates to rise and a cleansing deep recession to take hold.

Mr. Bernanke is trotting out the line he floated earlier in the year that the Fed is planning on tapering QE BUT is going to keep rates low (coupled with hints of negative interest rates from Janet Yellen) after they taper and shut down QE. Mr.Bernanke is betting again that the Fed can achieve low interest rates without printing money to buy $85 billion worth of U.S. Treasuries and mortgage backed securities each month and that it can have its recovQEry without the QE.

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This is a ruse and if tried, a gambit destined to fail. We saw what happened the last time the Fed tried to signal that they might taper the QE program – the interest rate on the ten year note shot up from 1.6% to 3%. As a result the Fed, after signaling that a taper was imminent, had to take taper off the table in September citing “tightening economic conditions” (higher interest rates) and a slowing housing “recovqery” engendered by too much Fed taper talk.

Now tapering is back “on the table” for the Fed’s December meeting. Earlier in the week, the normally dovish New York Fed President William Dudley offered an upbeat view of the economy, signalling that the Fed might taper QE soon. Then we heard taper talk from two more Fed Presidents – Dennis Lockhart of Atlanta and James Bullard* of St. Louis. Yesterday the Fed’s October minutes were released and indicated that the Fed may consider tapering in December.

Rates shot up again when the Fed minutes were released as the bond market priced in a dreaded taper.

The most recent Fed talking points are that the economy and job markets are improving, or are expected to improve but whether to taper QE is data dependent and they just need more time to confirm that the recovery has taken hold, but are pretty confident that it has. This is the same Fed taper talk we have heard on and off for the past five years. Somehow the recovery, never seems to sustain itself and QE continues driving the stock and real estate markets higher while doing nothing for the overall economy or job market.

Just last week Janet Yellen’s dovish remarks at her Senate confirmation hearings to become the new Fed Chair and comments by Fed President Charles Evans- “we are here to deliver job growth” and James Bullard “no rush to end the stimulus, inflation is low” assured the markets that QE would not be tapered until sometime next year.

The Fed is trying to prepare us for a fantasy low interest rate world without QE. The tapering is not tightening meme is not going over well with the bond market as we saw rates rise rapidly earlier this year when they tried to sell that line and this week when it was floated again. Just saying rates are going to kept low will not be enough to keep them low- QE will be needed.

The Fed may just try to taper QE one day soon and after doing so insist rates should stay low because they say so. If they pull the taper trigger and rates skyrocket and home prices and the stock market plummet, you can bet the new Fed Chair will be insisting on a return to the printing press to try and reverse the direction of interest rates.

At that point we will know that the Fed has lost control of the bond market.

Reagan to the Fed on Tapering QE and the Improving Economy – There You Go Again

*Just a few weeks earlier Mr.Bullard, like Mr. Dudley was in the QE tapering can wait camp. Bullard has been talking out of both sides of his mouth for months, alternating from ultra dovish remarks to flirting with hawkish sentiments.