The Fed is Beginning to Splinter… What Comes Next?
‘The following
is an excerpt from our most recent issue of Private Wealth Advisory. In it we outline a recent
development on the Fed’s Board of Directors. The implications of this will be
severe for all asset classes.
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The Fed is growing
increasingly splintered as an organization.
The media hasn’t
really picked up on this issue yet. But once they do things could become quite
problematic for the Fed.
Remember, the
primary force that has held the financial system together since the Crash of
2008 was the view that the Fed could backstop everything.
However, dissent
is now growing at the Fed… which means it will be harder for it to move forward
in a unified fashion.
Consider its
recent FOMC minutes released on January 3 2013.
With regard to the
possible costs and risks of purchases, a number of participants
expressed the concern that additional purchases could complicate the
Committee’s efforts to eventually withdraw monetary policy accommodation, for
example, by potentially causing inflation expectations to rise or by impairing
the future implementation of monetary policy. Participants
also discussed the implications of continued asset purchases for the size of
the Federal Reserve’s balance sheet. Depending on the path for the
balance sheet and interest rates, the Federal Reserve’s net income and its
remittances to the Treasury could be significantly affected during the period
of policy normalization. Participants noted that the Committee would
need to continue to assess whether large purchases were having adverse effects
on market functioning and financial stability. They expressed a range of views
on the appropriate pace of purchases, both now and as the outlook evolved.
It was agreed that both the efficacy and the costs would need to be carefully
monitored and taken into account in determining the size, pace, and composition
of asset purchases.
Source: Fed FOMC
minutes
Remember, the Fed
only just announced QE 3 in September 2012 and QE 4 in December 2012. At the
time of these announcements, the media heralded these moves as indicating that
the Fed would act aggressively forever.
And yet, today we
find that the Fed was actually conflicted about announcing QE 4 and was
questioning the benefits of QE the very day that QE 4 was announced.
As we noted in last issue The Great Global Rig of 2012 is Ending, the
schemes and policies implemented to hold the system together (including QE) are
beginning to lose their effect on the system.
On that note, let
us turn our attention to the Fed’s actual activity.
Since September
2011, the US Federal Reserve has announced Operation Twist (extending this
beyond its original deadline) as well as QE 3 and QE 4. And yet, in spite of
these numerous programs, until January 10 2013 the Fed’s balance sheet was
actually smaller than it was the year before (the blue line below).
Throughout this
period, the S&P 500 (the red line below) began to disconnect from the Fed’s
actual activity. Note how the market continued to rally even when the Fed’s
balance sheet was contracting throughout most of 2012.
Why is this?
Because, starting
in late 2011 and continuing to the present, the Fed has discovered that verbal
intervention has the same impact as actual monetary intervention. Why actually
spend the money when you can simply state on TV that you will act if needed and
the markets react the same way as if you had announced a new program?
Between the end of
QE 2 in June 2011 and the start of QE 3 in September 2012, the Fed resorted
time and again to implying it stood ready to act at any time. Despite over
eight FOMC meetings in which the Fed didn’t announce QE the markets
continued to general push higher on hype and hope of more QE.
Between this, the
Fed’s most recent FOMC minutes in which multiple Fed members expressed concern
about the efficacy of QE, and the fact that the Fed balance sheet only just
eclipsed its previous year levels on January 10 2013 (despite QE 3 and 4 being
announced in the second half of 2012), we can draw some very strong
conclusions:
1) The
Fed is growing splintered on how to proceed from a policy standpoint.
2)
This splintering will have political implications (Bernanke will likely step
down at the end of his term in early 2014, if not before)
3)
This splintering will have major financial implications for every
asset class particularly stocks which have become completely
disconnected from economic realities.
This is precisely
the sort of “unquantifiable” investment analysis we specialize in with our Private Wealth Advisory newsletter.
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