Wednesday, December 18, 2013

The Fed Gets it Right

It seems that Chairman Bernanke's decision to taper accompanied by very aggressive forward guidance was following the script I laid out for Janet Yellen in early November. (See Today the Fed announced that it would reduce their $85 billion/month bond buying program by a modest $10 billion and specifically stated that it will maintain its zero interest rate policy "well past the time the unemployment rate drops to 6.5%, especially if inflation continues to run below 2%."

In what looks like zero rates forever, or until well into 2015, the stock market ignited and bonds were range bound. It seems that the Fed played the stock market like a violin and avoided a feared sell-off. Instead of being the Grinch that stole Christmas the forward guidance popped the champagne corks in the equity markets.

Once the fireworks die down I suspect the markets will soon turn their attention away from the labor market and towards the inflation gauges. As I wrote in my latest UCLA Forecast, inflation will be an issue sooner than the market thinks. Even Chairman Bernanke noted in his news conference that health care inflation has been unduly suppressed. That along with rising housing costs will cause the core consumer price index to be running at a 2% rate by the second quarter and the Fed's preferred measure, the core consumption deflator, will be there by early 2015. Thus by the spring, the markets will begin to price in a quicker exit from the zero rate policy than now anticipated.

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