Is the Fed’s Punchbowl Running on Empty?

A recent Wall Street Journal article caused a stir in financial markets this week. “Fed Maps Exit From Stimulus” proclaimed the headline written by reporter Jon Hilsenrath, who many believe has the inside scoop on Federal Reserve policy.

Indeed the Fed’s foray into quantitative easing … now in its fourth installment (QEIV) since the depths of the financial crisis in 2008, has been widely credited with elevating stock prices. With the Dow Jones Industrials surging above the 15,000 mark, it makes sense why investors might be concerned about the Fed removing the punch bowl and spoiling the easy money bull market.

As shown in the chart below, the stock market’s rally since the 2009 lows has tracked nearly in lock-step with the Fed’s unprecedented monetary expansion.

Click for larger version

And it’s not just the Fed; this monetary parlor-game is global …

The Bank of Japan (BOJ) has launched yet another asset purchase program to boost its ailing economy and stock market. There have been so many stimulus plans from the BOJ leading to so many false-starts in Japan over the past two lost decades that I’ve lost count. Perhaps this time it’s different.

If the Fed is too quick to curtail QEIV, it certainly has the potential to disrupt stock and bond markets.

Even the normally stoic European Central Bank threw in the towel recently and cut benchmark interest rates in hopes of stimulating its way out of a deepening recession. In fact, after recent interest rate reductions by South Korea, Australia, and Poland, the total number of global central bank rate cuts now stands at 510 worldwide since 2007 … and counting!

The world is awash in a sea of easy money, so much that it’s hard to imagine stocks continuing to rally without this stimulus. Naturally, the Fed’s eventual exit strategy is a matter of intense interest, not only to U.S. investors, but to markets around the world, which often take their cues from U.S. policy.

But this epidemic of anxiety about the end of easy money may be much ado about nothing.

Fed Bound to Keep the Money Flowing

Several Fed officials have recently made public comments about a potential exit strategy, and have openly spoken about “dialing back” the Fed’s current $85 billion per month in asset purchases, perhaps as soon as later this year. Not wanting to abruptly spoil the party, Richard Fisher, President of the Federal Reserve Bank of Dallas clarified by saying: “I don’t want to go from wild turkey to cold turkey.”

If the Fed is too quick to curtail QEIV, it certainly has the potential to disrupt financial markets, causing gyrations in stocks and bonds.

Should the Fed wait too long however, the inflation genie could slip out of the bottle, and the Fed will find itself hopelessly behind the curve in combating expectations of higher prices.

If the choice is between the Fed acting too soon, or too late, my money is on the punchbowl staying put for awhile.

The Fed is closely watching two flawed government data sets to determine monetary policy:

• The unemployment rate — now at 7.5 percent and declining, but it’s clear the Fed would be more comfortable with a lower jobless rate

• The rate of inflation — currently 1.5 percent, which is well below the Fed’s 2 percent comfort zone.

In other words, judging from the Fed’s preferred monetary policy indicators, flawed as they are, it seems clear they are bound to err on the side of easy money.

Click for larger version

The outcome of the Fed’s next monetary policy meeting in June may be watched more closely than usual, but I doubt the Fed will call an early end to QEIV anytime soon. My bet is the Fed will indeed end up well behind the curve.

Interviewed on CNBC yesterday, hedge fund manager David Tepper, who correctly turned ultra bullish on stocks when the Fed launched QEIV last year, believes concerns about an end to stimulus is overblown.

He explained that fears the Fed will end easy money is “a backwards argument.” In fact, he hopes the Fed does begin to curtail its bond buying sooner rather than later, because that would mean the private sector is healthy enough to drive the economy on its own, without need of artificial stimulus from the Fed.

Surely the Treasury Department can find better ways to invest taxpayers’ money than buying Treasury bonds at or near record low yields … and record high prices.

Good investing,

Mike Burnick

Mike Burnick, with 30 years of professional investment experience, is the Executive Director for The Edelson Institute, where he is the editor of Real Wealth Report, Gold Mining Millionaire, and E-Wave Trader. Mike has been a Registered Investment Adviser and portfolio manager responsible for the day-to-day operations of a mutual fund. He also served as Director of Research for Weiss Capital Management, where he assisted with trading and asset-allocation responsibilities for a $5 million ETF portfolio.