The Fed surprised markets today by not beginning to taper
the massive QE program. Markets were generally expecting a $10-15 billion
reduction and jumped sharply higher on the news. The supposedly more
transparent Fed was anything but with this announcement. This could cause
more volatility going forward as it introduces more uncertainty as to what the
Fed will do. One thing for certain is that the taper will not begin under
Bernanke’s watch. He is getting out before the hard part comes and
currently his most probable successor, Janet Yellen, is the most dovish policy
member. That means it will be awhile before QE is ended and even longer
for an interest rate increase.
Personally, I think the Fed dropped the ball. Better
to start to rein in QE now when things are not bad and let interest rates get
back to normal. The important price signal that interest rates provide to
the economy has been muted for too long and is now hindering economic growth.
The longer the Fed continues QE the longer we will have subpar growth.
The longer they wait the harder it will be to do it down the road.
As I have often stated, if the economy does improve the Fed will be forced to
tighten which has a dampening effect on the economy bringing us right back down
to subpar growth. If they don’t tighten when economic growth increases
then the inflation monster will rear its ugly head.
We will have to see how this plays out in the markets over
the next while, but this might provide an opportunity for bond investors to sell
into strength if rates on the 10 Yr head back down towards 2.5% or lower.