The New Chairperson of the Federal Reserve showed off her dovish feathers
after the latest meeting of the FOMC. Ms. Yellen abrogated the threshold of
6.5% on the unemployment rate as the starting point for short term rate hikes
and replaced it with amorphous and ambiguous language that allows plenty of
wiggle room with rates.
Just like a child sometimes changes the rules of a game in mid-stream in order
to guarantee a favorable outcome, the Fed has ripped up the rulebook to suit
its own needs.
The Fed was fully aware when it first stipulated its guidelines for starting
rate hikes, that a 6.5% unemployment rate threshold could be breached with
the help of a contraction in the labor force participation rate and not fully
through increased hiring. However, it still drew a line in the sand in which
investors were forced to determine when the cost of borrowing money would begin
to be increased directly by the central bank.
To the central bank's credit it did follow through on the promised continued
reduction of asset purchases by $10 billion per month. The Fed is now purchasing
$30 billion in Treasuries and $25 billion worth of MBS. This reduction was
already in the cards and didn't surprise anyone. Nevertheless, the Fed completely
abolished a numerical threshold for the unemployment rate to fall below before
it begins to raise the Fed Funds Rate. The reason for this is clear; the Fed
realizes it cannot raise short-term rates without pricking the asset bubbles
it has worked so hard at creating and sending the economy into a deflationary
tailspin.
The condition of the U.S. economy (and indeed global GDP as a whole) is so
anemic that even after 5+ years of massive Federal Reserve market manipulations,
the Fed cannot raise short-term interest rates. In other words, they will keep
making excuses as to why they can't raise interest rates and continue to move
the goal posts for their convenience.
The Fed is in the process of trying to end QE, but the stock market and Fed
don't yet realize that the tapering of asset purchases is tightening monetary
policy. This will cause long-term interest rates to rise -- and the worst is
still to come. For instance, the 10-Year jumped to 2.77%, from 2.68% on the
same day of FOMC's decision to reduce asset purchases by another $10 billion.
And short-term rates are rising to an even greater extent, despite the fact
that the Fed is still posting a bid of $55 billion each month for these debt
instruments.
The Federal Reserve's quantitative easing program was the only reason why
the 10-Year Note, and longer-term interest rates in general, are as low as
they are today. Ending QE will cause a huge spike at the long-end of the yield
curve unless the economy is sharply contracting. Whether or not the Fed admits
this is irrelevant.
The fact is the Fed is going from buying all of the newly issued Treasury
debt, to zero of the newly issued debt market. And there isn't any entity that
I am aware of in the entire world that will supplant the Fed's purchases at
anywhere near today's rates. So interest rates are going to rise, and that
is deflationary and also bullish for the U.S. dollar in the short-term.
But the anemic economic data should continue to worsen as interest rates rise.
This means that the Fed will stop tapering sometime in the very near future
-- probably in the summer or early fall -- and then they will feel compelled
to launch QE V. When this shift in policy takes place it will be incredibly
significant for world markets--beyond anything we have seen before.
In the interim, investors that have bet on an easy escape from QE will find
out how wrong they have been. The equity market should undergo a severe correction
once it becomes clear that asset prices and the economy have been highly reliant
on debt monetization from the Fed.
The gold market has priced in a worst case scenario for the yellow metal--a
balanced budget and no growth in the money supply. That's clearly not going
to happen. In fact, the opposite is much more likely to occur. However, as
I've stated many times before, the major move higher in precious metals won't
occur until the overwhelmingly-accepted notion regarding the Fed's ability
to end QE and raise interest rates with full impunity is proven to be fantasy.
Therefore, a significant spike in hard asset values will occur when the Fed
acknowledges the fact that there is no easy escape from QE and the economy
is destined to head into a deflationary collapse without the Fed's continuous
support of bond prices. Although that would be healthy for the economy in the
long term, it isn't going to happen voluntarily because of the hubris of politicians
and their constituents. The Fed will stop tapering and undergo a massive and
extended QE program in the latter part of 2014. That is when investors need
to go all-in on inflation hedged securities. Until then, it is prudent to hold
an abnormally high level of cash in your portfolio to be able to take advantage
of the coming selloff.
