Dow Jones Industrial Average: The Fed Is Backed Into A Corner

Janet-YellenSy Harding:  The minutes of the Fed’s last FOMC meeting, released this week, confirm that the Fed believes it must begin to taper back its stimulus soon. At this point, the longer QE continues the greater the risk of asset bubbles forming, the bursting of which would destabilize the economy and make it even more difficult to exit.

Economists and analysts have been concerned from the beginning about how the Fed would be able to reverse the massive QE stimulus, which has been the major driving force of the anemic economic recovery and the powerful bull market in stocks, without also reversing the momentum of both.

Fed Chairman Bernanke has always provided assurances that the Fed would have ways of doing that when the time arrives.

But the Fed’s guidance and actions so far this year have indicated that it does not have a firm exit strategy in place at all. Since its first hints in May that it had begun thinking about tapering, it has looked very much like the Fed was experimenting, throwing out various trial balloons to test the reaction of markets, and then pulling them back in each time when it didn’t like what it saw.

Each of the Fed’s hints about tapering in May, August, and September sent markets tumbling, until the Fed rushed back in each time to say that markets had misunderstood, that it wasn’t going to do it right away.

Dow Jones Industrial Average (INDEXDJX:.DJI)

The minutes of the last FOMC meeting, released this week, convey much the same picture, of a Fed that is anxious to begin tapering but worried about how to go about it.

Much of the meeting seemed to center around not just when tapering should begin, but more so on how to manage it without panicking markets. Participants discussed the wording that could be used in introducing the change, and new promises that could be made in the Fed’s forward guidance, while worrying that “communicating them could present challenges”.

Among the thoughts expressed were that “It might be appropriate to offset the effects of reduced QE purchases by undertaking alternative actions to provide accommodation at the same time.” Or that it could change its current forward guidance that it will keep interest rates near zero until unemployment falls to 6.5%, to a promise to do so until joblessness reaches an even lower level, which Chairman Bernanke floated in a speech this week.

Clearly the Fed sees it has a problem as it moves toward actual tapering, if just the hints of tapering began to panic markets this summer.

Meanwhile, conditions are not cooperating either.

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