The Fed’s Failed Strategy Is Dying a Slow Death

The shift in expectations for the Federal Reserve to taper its quantitative-easing program has been nothing short of breathtaking over the past several weeks.

In the wake of the Fed’s surprise September decision to postpone the start of that process, Wall Street’s short-term thinkers did a complete 180.

They went from predicting a near-immediate start to tapering to predicting that tapering wouldn’t start until well into 2014, perhaps as late as June.

[Editor’s note: To learn how the Fed’s new policy can hurt your investments, click here for an audio extra.]

One market watcher at Deutsche Bank went so far as to literally suggest the Fed should ask itself: “Why bother to taper at all?”

Me? I’ve tried for several months to take a longer-term view and not be swayed by every market gyration. I’ve also tried to be as crystal clear as I can about something very important: The ongoing rounds of QE have been positively useless when it comes to bolstering the “real” economy.

While there was no clear signal on when the Fed might scale back QE, the post-meeting statement was more bullish on the economy than some were expecting.

The Fed, over several years and a few trillion dollars of bond buying, has failed to deliver GDP growth of 3 percent, 4 percent, 5 percent or more, growth that would represent a strong recovery. The Fed has failed to spur companies to add 300,000 or 400,000 jobs a month. And the Fed has failed to trigger huge growth in durable-goods orders, lift consumer sentiment or give us 1990s-style manufacturing or service-sector strength.

Instead, the economy has gradually healed over time on its own. It isn’t growing at a brisk pace, but it isn’t shrinking either. There’s nothing out there to justify the lowest level of interest rates in history, for the longest period of time in history. Nor is there anything going on to justify the same kind of massive money printing we saw in the depths of the Great Recession in 2008.

So what did QE “accomplish”?

It managed to inflate the biggest bond bubble in the history of the world. That sucked in millions of investors, who collectively shoveled roughly $1.4 trillion into bond mutual funds and ETFs chasing performance — just like they poured money into tech stocks in the late 1990s.

The problem is that bubbles and bubble-inducing policies can’t continue forever. They eventually reach a point where they collapse under their own weight. I believe we saw the first phase of that collapse this spring, and now, the second phase of that collapse may be about to get under way.

That brings me to this week’s Fed meeting. As expected, the central bank on Wednesday did nothing in terms of changing policy — it maintained the $85-billion-a-month pace of asset purchases. And, as expected, the Fed continued to talk about maintaining relatively easy policy.

But I believe the post-meeting statement was actually more bullish on the economy than some were expecting. The Fed said that “the Committee sees the downside risks to the outlook for the economy and the labor market as having diminished, on net, since last fall.” And also that “the Committee sees the improvement in economic activity and labor market conditions since it began its asset-purchase program as consistent with growing underlying strength in the broader economy.”

More importantly, the Fed mentioned in a couple of places that fiscal policy was the problem. That suggests to me that the Fed thinks market players should stop counting on monetary policy to solve the economy’s woes. The statement also reminded investors that “asset purchases are not on a preset course, and the Committee’s decisions about their pace will remain contingent on the Committee’s economic outlook as well as its assessment of the likely efficacy and costs of such purchases.”

In short, I’ve been reading and analyzing Fed statements and speeches for a long time. I can tell you that many on the Fed have clearly been nervous about the bubbles their policies are inflating, and clearly want out of QE.

This week’s statement did nothing to dispel that belief. As a matter of fact, it went out of its way to gloss over the economic impact of the government shutdown, to reiterate that QE has costs, and to make it abundantly clear that QE is not on a pre-set course.

So, no, I do not believe QE will go on forever. I do not believe tapering is off the table until kingdom come. Instead, I believe QE will likely die a slow death over the coming months and that, afterward, the Fed will be forced to actually raise short-term interest rates sooner than the market currently expects.

That’s why I remain extremely leery of many fixed-income investments. It’s also why I’d rather direct my funds to specific stocks and sectors that have little or no interest-rate exposure, and that do not need massive infusions of QE to deliver solid results. You’ll find my Safe Money Report chock full of those kinds of names, so if you haven’t already given it a try, why not click here and do so today?

Until next time,

Mike