The Fed’s fear of a taper
For many analysts, it was what the Federal Reserve didn't say that spoke volumes.
Last week, Fed watchers, the modern financial equivalents of Kremlinologists, were out in force. Analysts noted that the US Federal Reserve failed to mention the potential impact of the government shutdown on the economy.
It also omitted a reference to "the tightening of financial conditions", which it mentioned in September. That referred to the sharp rise in bond yields, or long-term interest rates, which followed its first hint in the spring that it might taper quantitative easing (QE). Higher bond yields reflect falling prices.
Now most analysts reckon the Fed is feeling slightly less dovish than everyone thought. The upshot is that it may begin to taper' its money-printing programme by the end of 2013 rather than in the spring. It currently buys $85bn of bonds with newly created money every month.
Don't count on early tapering, says Liam Halligan in The Sunday Telegraph. The Fed has simply stopped talking about tightening financial conditions because it is avoiding the topic of tapering altogether.
The US central bank has "lost its nerve" after markets reacted like "addicts contemplating cold turkey" when it first mooted tapering in May. "This illustrates the Fed's Catch-22." If chairman Ben Bernanke starts preparing the world for tapering again, yields will rise rapidly once more, "choking off recovery and robbing the Fed of its resolve to taper".
Yet QE is already becoming "destabilising", says Doug Noland of the Credit Bubble Bulletin. Monetary policy has remained "ultra-loose for way too long". If the Fed keeps going at this rate, it will have printed money worth 30% of US GDP by June 2014. This has not secured a sustainable recovery, but the money has found its way into asset markets.
While economic and profit growth remain lacklustre, investors are addicted to Fed liquidity, sending stocks ever higher. The latest survey of sentiment in the US market revealed just 16.5% of investment newsletter writers were bears, "about as low as it gets", says Randall F Forsyth in Barron's.
Citigroup's Panic/Euphoria gauge hasn't been this skewed towards the latter since 2008. The median price-to-sales ratio is at a record high.
We're seeing "bubble-like markets again" and it's "imperative that the Fed begin to taper", agrees Blackrock's Larry Fink. Yet it seems the Fed daren't, for fear of causing a nasty slide in assets and choking off the recovery. That presages an even bigger bust in the future.