We know we
just changed our comments to the first Thursday of every month rather than each
Thursday. However, we thought it might
make sense to write this comment since we have been discussing what would
happen when the Fed’s monetary ease comes to a halt.
The
financial press and media were at first concerned about the Portugal,
Argentina, and Ukraine problems as well as the Russian sanctions, but the
overriding problem was the potential for reversing the monetary easing. We had a taste of the Fed possibly raising
rates a little earlier than expected when the Employment Cost Index rose 0.7% for the second quarter.
This was the largest increase for the past 6 years. After this was released the Dow Jones Industrials erased all the gains for the year by dropping over 300 points. We have consistently warned our readers about
the ramifications of the unwinding of the Fed’s loose monetary policies of the
past few years.
In fact, we
just wrote on June 19th, “What Happens When the Fed Unwinds Their
Balance Sheet?” In it we stated, “The
Fed has tried to stop QE strategies before but were unsuccessful. During the first two QE programs, they set a
date when the programs would end. Once
those dates were announced, the markets began to unravel which resulted in the Fed
starting another QE. They essentially
had to start a new QE in order to keep the “wealth effect” alive. Apparently, they noticed that stopping their
programs at a specific date was not working, so they came up with the idea of
getting out gradually (tapering) as if no one will notice and everything will
go back to normal.” We also stated, “However,
we believe the market will correct significantly before the Fed ends the
tapering of the bond purchases.” We also
stated that if and when the market corrects, the Fed may change course and
start another QE.
For all the
people that believe the Fed is omnipotent, you have to keep in mind that the
Fed did not see the bubble that they were causing in housing all through 2003,
2004, 2005, 2006, and 2007 when they lowered Fed Funds to 1% in June of 2003
and kept it there for a year. They also
watched as banks and mortgage companies enticed every American with a heartbeat
to buy homes they couldn’t afford. The
Fed had to use loose monetary policy after the housing bubble burst, but they
still never believed that they caused the bubble in the first place. Greenspan proclaimed that it is
impossible to recognize a bubble until it bursts—and remember Greenspan had the
control of the Fed throughout 2003, 2004, and 2005.
The problem
with what the Fed is doing now, is that they have taken the policies that were
needed in 2009 with QE-1, 2010 with QE-2, and started the latest QE-3 that was
driven by bond purchases, and no ending time limit (this is why it was called “QE
to Infinity”). The problem with what the
Fed has done is that they have taken the policies needed with “QE to infinity”
is that it got out of control by expanding the Fed’s balance sheet from $800
billion to $4.4 trillion while keeping the Fed Funds rate at close to
zero. The negative
stock market’s reactions to the unwinding of their balance sheet, or even just
any indication of rising interest rates will be a problem for the stock market.
Now, every time there is any indication of the Fed raising interest rates
or the unwinding of their balance sheet, we believe the ending of this
excessive monetary policy will be ugly!