Are we ready for Tapering?

Many of our peers take a moment at this time of year to post a “mid-year review” in order to reflect on their philiosophies in relation to market performances. While that can be interesting, we find ourselves looking ahead. And sadly, thanks to our Federal Reserve monetary policies, the immediate future looks cloudy.

Let’s pause for a moment and reflect on any of the 12 policies the Fed has introduced since 2009 to help prevent deflation (QE1, QE2, QE3, Operation Twist, etc). We could easily debate the philosophies or the unitended consequences, but let’s step back this week and ask: when will the economy eventually be healthy enough to grow on its own?

Most recently, that question was addressed by Fed Chairman Bernanke that we will “taper” (meaning not stop, but simply do less of) the $85B/month bond buying program as early as September of this year.  Pay close attention here because this “tapering” strategy only means a reduction in the current bond buying program, and does not mean and end to overall stimulus (which the Fed must continue in order to support the USD as the world’s reserve currency).

The fact is, the Fed has tried many times in the past to end their stimulus programs, but each attempt has failed, forcing the Fed quickly to rush back in with a more easing.  Remember, the end of QE1 only lead to QE2… that, of course ended leading to Operation Twist… which later had to be extended… leading the Fed to announce QE3… which 3 months later had to be increased… sadly, you get the picture.  Every time the Fed tries to take their foot off the gas, the markets throw a fit and Ben Bernanke immediately rushes back to a new stimulus plan.

Take a look at the chart below to see how the S&P 500 has performed during times of stimulus vs. times of no stimulus:

Let’s start with the obvious: the stock market likes free money. And let’s be honest – everyone loves a free lunch, right?

So let’s then look at the natural converse of the market’s exuberance: This ride is being fueled by an artifical stimulant, which at some point has to end.

As much as the equity and housing markets have enjoyed the free ride, most economists agree that eventually, there must be an exit plan. In fact, back in May Mr. Bernanke very delicately tested his exit strategy by introducing the idea that the Fed might “taper” as early as September of this year (presumably to test the waters on how the economy would react this time if stimulus were ended).

And what happened?  You can probably guess… Even the slightest hint at the withdrawing stimulus caused interest rates so spike and sent world markets into a tailspin.

Not convinced? The following chart shows what happened to the rates on 30 yr fixed mortgages:

That sharp line up on the far right is a picture of the bond market reacting to the mere suggestion of tapering.

We must remember: this was not a reaction to an actual policy announcement… just the very mention of it! Last week, CNBC ran a story about how the sharply rising mortgage rates were making it more difficult for prospective buyers to qualify for homes that would have been no problem a few months ago.  This is not what the Fed wants to see as housing is one of the main sectors that is supposed to lead the US economy back to strength…

We have more to say on this subject, including our prediction of how Mr. bernanke actually plans to exit federal stimulus once and for all, but we will pause here and ask:

Will the Fed actually taper in September?

As always, we welcome your comments and questions here, via email, or call us directly.

Categorized in: Blog

This post was written by Conscient Capital