Tapering or Discontinuing QE Was Not the Plan – June 21, 2013

Here’s the news of the week – and how we see it here at McAlvany Wealth Management:

Tapering or Discontinuing QE Was Not the Plan

In the latest FOMC meeting, Mr. Bernanke made the big things very clear. First, monetary easing of $85 billion per month will continue. Second, the Fed will add to or subtract from that commitment depending on economic conditions. So far, so good.

13, 6-21, Box ScoresIn the discussion that followed, any tapering of QE was strictly conditioned upon an improvement in the economy, or, more specifically in this case, unemployment (targeted now between 6.5% and 7.0%). Talking about tapering at all was likely an attempt to manipulate the Treasury rates and commodities markets lower without having to actually do anything. But because Bernanke belabored the issue, the mainstream media stopped its ears to nuance, publishing in the papers that very day and the next that tapering and/or an abrupt end to QE was now guaranteed – as early as mid-2014.

Whether the release of this interpretation was intended remains unknown. We do know that “jawboning” (words without ensuing deeds) has gone far in manipulating markets recently. In this instance, the game playing may have gone too far. All the markets that feed off of QE, both domestic and foreign, took the news hard (see the box scores). This included a sharp sell-off in Treasuries and mortgages, to the Fed’s distinct chagrin. The effect was the exact opposite of what it wanted or expected.

That has been the dilemma – how to print without adversely affecting the dollar and, ultimately, interest rates. For some time now, the Fed has wielded masterful control over these markets, but it’s becoming evident that the Fed is losing its grip. This is something we believe they are painfully aware of – which could explain Bernanke’s retirement plans. But make no mistake about it: For now, the plan is not to taper off of QE. As a debt-enslaved nation, we are hopelessly attached to this albatross – till death do us part. Instead, we expect the Fed to attack the symptoms (such as decline in the Treasury market and mortgage rate increases) rather than the cause (QE) like a cornered lion.

As if to affirm that assertion, Bloomberg ran a few pertinent articles on Friday. One was titled “U.S. Weighs Doubling Leverage Standard for Biggest Banks,” in which the U.S. government may mandate a doubling of reserves (i.e., Treasuries) in the nation’s largest banks. This is undoubtedly an effort to bolster the Treasury market and bring about the lower rates the Fed seeks. Another article was titled “Housing Seen Shrugging Off Rate Rise as Banks Loosen Mortgages.” It reports that banks have been loosening their lending standards, as they did in the 1990s, in order to counter the effects of higher mortgage rates on the bottom line. This is a tack they would never take unless they knew the Fed would back the loans if they sour. This hard evidence speaks louder than Fed jawboning or MSM delusion, and it tells us that QE is here to stay.

As money printing continues, we believe that its byproduct, inflation, will increasingly be in evidence as well. Though that hasn’t been the general view expressed within the investing community, we have never known a time when excessive money printing did not create an equally excessive amount of inflation, in one way, shape, or form. The recent rise in rates and weakness in the U.S. dollar (despite the Fed-induced spike this week) are giving substance to that age-old economic truth at an extremely delicate and highly leveraged juncture for equity and fixed income markets.

Best regards,

David Burgess
VP Investment Management