Thursday, September 19, 2013

The Fed Makes a Mistake

The Fed made a mistake yesterday in not modestly tapering back their quantitative easing program. Simply put the FOMC had a free option from the markets to start the long awaited process of gradually reducing their $85 billion/month bond buying program. Had they reduced the program to, say, $75 billion/month, it would have been a nonevent. After all what difference does a $10 billion change in a monthly bond buying program make for a $16 trillion economy? Instead by continuing the program at its current level, stocks and bonds soared. Also soaring were gold and oil prices and the U.S. dollar tanked. If Fed Chair Bernanke wants to get the inflation rate up to somewhat above the 2% target level, he is going to get that in spades.

Why? Despite all of the recent good news on the inflation front, underneath the data there are troubling signs that inflation will not be as modest as most market participants now expect. For example buried in August CPI report, medical care services surged 0.7% (up 3.1% year-over-year) and rent paid for a primary residence is also up 3% year-over-year. The Fed's move yesterday added fuel to the embers that will increase commodity and import prices.The upshot of it all is that already hard hit real wages will be hammered even harder. Perhaps that is what they want.

I fully understand that the FOMC was concerned about "tightening financial conditions" caused by Wall Street's "taper tantrum." Those concerns were manifested in a stall in the housing market that in all likelihood is temporary. If the FOMC was so concerned about this they could have toned down Wall Street's consensus expectations that called for a modest taper.  By failing to do this, the Fed has lost credibility and when the Fed finally moves to end the quantitative easing program that nearly all market participants and the Fed itself view as unsustainable, watch out below!

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