The key sentence in the Fed’s statement was, “The Committee is prepared to increase or reduce the pace of its purchases to maintain appropriate policy accommodation as the outlook for the labor market or inflation changes.” (Source: Board of Governors of the Federal Reserve System web site, May 1, 2013, last accessed May 2, 2013.)
Why is this so significant? For the past few months, many economists and analysts have been expecting that the Federal Reserve would begin to discuss when it would be appropriate to begin reducing its aggressive monetary policy program, specifically the monthly $85.0 billion bond-buying level.
Many were thinking that at this meeting the Federal Reserve would indicate that at some point in the future it would begin reducing its aggressive monetary policy stance. While the Fed did indicate that it might be prepared to reduce bond buying and lower monetary policy measures, this is the first mention in its press releases that an increase is possible.
In my opinion, this indicates that the Federal Reserve now believes that additional monetary policy might be necessary, whereas we all had been hoping that the U.S. economy would begin to improve. Clearly, the recent data has shown otherwise.
Job creation remains very weak, and various sectors, such as manufacturing, do not indicate that they will increase their level of production anytime soon. Internationally, we are also seeing continued weakness in many countries, which can only put downward pressure on our own economy.
With approximately 11.7 million people still out of work, the sentiment in the Fed’s press release that an increase is possible is a signal to me that the current easy money program is losing its effectiveness. The Federal Reserve committee still has two targets to hit: an unemployment rate below 6.5% and an inflation outlook that is below 2.5%.
The unemployment rate is nowhere near 6.5%, with the real unemployment rate being significantly higher. The Federal Reserve does understand that real unemployment is unbearably high, and its use of quantitative easing is the only tool it has at its disposal. Once again, the Fed did mention fiscal drag as being an impediment to growth. The politicians in Washington continue to cause havoc with the American economy, as people are uncertain about the future and fed up with both political sides.
This secondary target for the Federal Reserve is an inflation outlook below 2.5%. While the Fed might be currently meeting its target, as we’ve seen both consumer and producer core inflation far below 2.5%, such an aggressive monetary policy program will at some point raise concerns over the long-term costs. If inflation were to begin increasing, this could result in many asset classes moving upward in price, including commodities like gold.
The key question: can the Federal Reserve rein in monetary policy at a fast enough pace to prevent inflation? History has shown that the Fed has been quite slow at pulling back on quantitative easing, and this delay has created bubbles in the economy, which will create more havoc down the road. There are always costs that must be paid for such a monetary policy program.
But before we see quantitative easing come to an end, the current economic situation in America might very well warrant additional and more aggressive monetary policy by the Fed. The quotation that began this article clearly shows that the Federal Reserve is considering additional measures, which makes me worry about the true fundamental strength of the U.S. economy.
This article is brought to you courtesy of Sasha Cekerevac from Investment Contrarians.