"No man can become rich without himself enriching others"
Andrew Carnegie

Thursday, August 22, 2013

Fed Tapering: Misunderstood

English: Detail from Government. Mural by Elih...
English: Detail from Government. Mural by Elihu Vedder. Lobby to Main Reading Room, Library of Congress Thomas Jefferson Building, Washington, D.C.  (Photo credit: Wikipedia)
By Logic Fund Management

New York, Aug.22, hot stocks .- Today, we got a look at what the Fed was discussing at their July 31 FOMC meeting.

Again, it was another highly anticipated event for global markets.

Despite the lack of any material new news in recent weeks, the word taper has continued to dominate the headlines.

But I’m not sure why people are so fearful of the possibility that the Fed could scale down its third round of QE.

Now, I could do a deep-dive into today's Fed minutes for you, but admittedly, all of this hyper-analysis of the nuances and details of a Fed tapering is a bit ridiculous. What is being lost on everyone is what the Fed attempts to accomplish by its QE program.

To be sure, exactly how the transmission of QE helps the economy is inexact at best -- short of the downward pressure it's put on mortgage rates, from the Fed's MBS purchases. Even the Fed's Yellen, a proponent of QE and possible next Fed Chairman, has publicly said she can't prove it works directly to produce growth and drive inflation.

So what does QE do, ultimately? Here's what it does ...

It gives people the confidence, in a fragile world, that the Fed is still here, doing anything and everything necessary to defend against shocks and promote some stability. With that, people don't sit on their money. They don't hoard gold, and guns, and build a bunker. They live life. They start to invest again, and spend again.

Companies can plan. They can slowly begin to hire again. And that's what has happened.

As I've said in the past, this "confidence manipulation" strategy is key for the Fed. They don't have the policy tools (or latitude) to restructure global trade, the major structural issue that continues to overhang the global economy. But what they can control is confidence.

All of that said, the Fed appears to have realized that QE is just one of many tools that can accomplish that goal of producing confidence and stability. The ECB has shown them that making bold promises can achieve the same objective (i.e. just words). The ECB promised to keep their risky sovereign bond markets in check by threatening to buy as many shaky Spanish and Italian bonds as necessary to push rates back down to tolerable levels – enough said. They haven’t had to buy one single Spanish or Italian bond. Rates on those bonds have gone from ticking time bombs to attractive investments for global bond managers.

The bottom line: Global central banks have come to the conclusion that telling people you are constantly prepared to act, ready do anything necessary – meanwhile, telling them that rates will stay at record lows for a LONG time, can do the trick.

It makes the Fed wonder, why are we engaging the potential risks associated with QE, when it doesn't seem so necessary anymore?

From an investor’s perspective, the most important thing to keep in mind is this: The Fed and other global central banks have committed trillions of dollars to keep the world from spiraling into depression. They've continued to act all along the way (together) to promote stability in a fragile time. The last thing the Fed would do is anything to undo global economic stability, or anything to threaten the trillions of dollars in global central bank backstops.

Now, the biggest fear that has been expressed by market participants, surrounding Fed tapering of QE, has been the prospects that tapering will trigger a collapse in stocks. That's an outcome that would defeat the Fed's objectives, and it would be self-induced. Don't count on it. The Fed needs stocks higher and housing higher to fuel consumption.

For those that have been in the stock market collapse paranoia camp, consider this: Despite the many months of taper speculation, stocks are just 4% off of all-time record highs. And a September taper, while far from assured, is well priced into the market psyche.

Enhanced by Zemanta