This is a syndicated repost published with the permission of Money Morning. To view original, click here. Opinions herein are not those of the Wall Street Examiner or Lee Adler. Reposting does not imply endorsement. The information presented is for educational or entertainment purposes and is not individual investment advice.
Sifting through the Fedspeak, it became obvious that the Fed is now lining up a “monetary cliff” that’s bigger than the fiscal one we spent the last half of 2012 worrying about.
Let me explain…
Here’s Where the Fine Print Gets Interesting
According to the release from last week’s meeting, the Fed will continue to purchase $85 billion of Treasury and agency bonds every month. Doing so, Bernanke explained that at some point he does expect to reduce that amount. However, he also explained that the recent string of good unemployment data (five months above 200,000 new jobs) wasn’t enough yet for him to make the change.
The Fed also stated that it expects a “considerable period” to elapse between the conclusion of the purchase program and raising rates.
Interestingly, that matched with the intentions of the 19 Federal Open Market Committee members. Only a few expect to raise rates before the end of 2014, compatible with the current Fed outlook.
But here’s where the fine print gets really interesting: All but one of the members now expects to raise rates in 2015.
What’s more, they said once they start, they won’t be shy. In fact, the average opinion would put rates at 1.35% by the end of 2015. It may not seem like much at first glance but that’s actually quite a big move from six-plus years at zero. And further on into the future, the consensus long-term goal was for rates to hit 4%.
Of course, with inflation around 2%, my goal for the Fed funds rate would be higher than 4% and a lot higher than 1.35% by the end of 2015. But alas, I’m not the Fed chief.
The point is that with the Fed expecting the economy to grow steadily between now and then, and no immediate sign of even a slackening in bond purchases, the turn by the Fed supertanker in late 2014 and 2015 is going to be pretty abrupt.
In fact, chances are it will cause a big wake, and drown quite a few people who have become used to current policies.
In the year to September 2012, the Fed bought bonds covering about half the federal deficit; this year it will buy bonds covering 121% of the deficit; and next year, if bond purchases continue at the current rate, it will cover 166% of the deficit.
Congress has done its job, for a change. (Treasury Secretary Jack Lew must have been happy about this in China last week; for once he didn’t get smacked around by Chinese holders of U.S. Treasuries!)
But it does mean that the inflationary effect of Fed purchases is increasing, as is the boost they give to asset prices. After all, all of that “extra” liquidity has to find a home.
A Difficult Turn for Investors
For us as investors that makes life bloody difficult.
At the moment, Fed policy is getting more and more “stimulative.” As a result, for the moment we can expect a strong stock market, rising commodity prices and, with a bit of luck, a nice run in gold and silver. The U.S. economy should also continue its current sluggish but adequate growth.
Mad money printing by the Japanese under their new central bank governor, by the British trying to kick-start growth, and by the Europeans trying to stop the euro falling apart, will only exacerbate this tendency.
But at some point, probably around mid-2014 if you asked me to guess, the Fed will notice that 2015 is approaching, that unemployment is still trending down, and that inflation is trending upwards, above their “target” 2% — however much they try to fudge it.
That’s the point when the Fed will take the first tentative step towards tightening.
The market will then see that the easy-money game from which it has done so well is over, and that a lot of tightening is to come quite soon.
In all likelihood, it will panic. Bull market constructions such as mortgage REITs and leveraged buyouts will totter. And we will head into a credit crunch that will differ from 2008 only in that governments won’t be able to bail us out.
Because interest rates will already be near zero, inflation will be rising and debt will be too high.
For investors that doesn’t paint a very rosy medium-term outlook for the markets. The truth is we may need to be 100% long for the next year, then at some point reverse quickly to become 100% short. Given the timing it promises to be no fun at all.
Of course, the Fed could pre-empt this by beginning its tightening now, while the stock market is still only around its old record and inflation is quiescent.
By doing so, it would signal to the market not to get over-excited and would turn the monetary supertanker more slowly. For the next 12-15 months, unemployment declines would be lower than projected. But avoiding the meltdown 15 months out would really make life easier in the long run, even for the unemployed.
But let’s just say, I’m not holding my breath on that one. I’ve been watching Ben Bernanke for far too long.
Related Story Links:
- Money Morning:
Why Now Is the Time to Add Australia to Your Portfolio
- Money Morning:
Here’s the Surprising Winner of the Currency Wars
- Money Morning:
The Eurozone Hangs On By a Whisker
- Money Morning:
2013 Dividend Stock Forecast: The Road to True Wealth Starts Here