Does Your Cup Runneth Over? Explaining the Fed’s Approach to QE

Scott Shellady |

Taper or not to taper? That is the question at hand. To make it simpler, I think that there a few good examples on what the Fed is doing to our market.

Think of our economy as a bathtub, with all of the commerce and banking operations swirling around it every day. The Quantitative Easing that the Fed has embarked upon is the faucet tap that fills the tub. If there is a lot of QE, the faucet is running fast, a little QE and the faucet slows to a drip.

Now imagine that the drain is a function of interest rates. Taking water (liquidity) out of the tub is tightening, stopping up the drain to add liquid(ity) is easing or accommodation.

These are the two functions facing the Fed and how they handle the situation will have a direct impact on equity prices and returns. The talk as of late has been a call to taper. Last summer the taper drums had been beating hard. There were multiple economists calling for some sort of taper at the September Fed meeting. All the while the Fed kept saying that they are ‘data dependent.’ They didn’t say this just once, not even twice but a number of times. There was no call to taper.

And still, the data has been coming in tepid at best. While some would like to look through rose-colored glasses, the economy is still struggling to recover. Fourth quarter GDP is forecast to come in at 1-2%. We still have a 7 % unemployment rate.  48 million Americans are on food stamps – a record. Where is all this so called good news coming from?

Some U.S. corporations have been doing a little better. The jobless rate has slowly been declining. Home prices look to have bottomed out. GDP is at least a positive and not negative. Inflation is under control. But, are these inputs strong enough to push the hand of the Fed? I think not.

Ben Bernanke’s last meeting is next week. Janet Yellen is to start her first meeting in January. We have had a couple of good economic figures lately but I would still argue that a large number of the economic numbers have been coming in worse than expected or at best, not as bad as expected. We still aren’t ripping the cover off the ball and we are accommodating at an unprecedented rate. And then there is 1937.

In late 1936 and early 1937 the Fed began to tighten monetary policy because we had inflationary pressures and continuous growth from 1932 on. It was a disaster. We didn’t fully recover until 1945. The Second World War was what brought us out of the tailspin.

Ben Bernanke does not want to become Marriner S. Eccles – the Fed chairman who oversaw this premature tightening. The Fed and Ben Bernanke will have learned this lesson. It is better to be late to the party when it comes to tightening or tapering . The effects of a premature tightening are exponentially damaging. That is why you may see the Fed balk at any change at the next few meetings.

So here we sit and wait on the Fed’s next move .While the current policy is trying to borrow growth from five years out, it hasn’t been successful. We have tried to inflate ourselves out and it hasn’t materialized. With all of this accommodation we do not have a lot to show for it.  Higher equity prices and a larger gap between the rich and poor is a direct result. Main Street has been left out of the wealth creation from 2008 onwards – remember, 5 percent of Americans own 82 percent of stocks.

The debate that will rage is going to come from two camps. On one hand we have those who believe that albeit a slow recovery, at least we have one. Their thought is that we cannot continue to expand our balance sheet forever. They believe that things are pointing in the right direction and corporations have been doing well. Valuations are fair because corporate America is back. I’m not so sure.

The other camp is made up of those that think that without QE, these equity prices would be a lot lower. The equity market has seen a 180 percent increase from its 2008 lows while the economy continues to limp along. Equities have been the only thing that those with money can invest in and it will somehow be backed by the confidence that the Fed is still printing money.

In the middle we have the Fed.

The Fed is going to be caught with no way out. They can’t please both sides. Their job next year will be to slowly massage the market with rhetoric while at the same time trim asset purchases. That is why I think that they will give us a little of both.

My feelings are that they will maybe announce a tapering measure and it could be sooner rather than later but it will be wrapped in forward guidance. They will say something like “tapering will begin… but not until March 1.” I think this would be a good thing for the market and might actually give the Fed a chance to be ‘data dependent’, watching the economic figures come in, while all the while maintaining the opportunity to change their forward guidance.

The cup is not running over, but it’s getting pretty close.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

Companies

Symbol Name Price Change % Volume
EZENQ Ezenia! Inc n/a n/a n/a n/a

Comments

Emerging Growth

H-Source Holdings Ltd.

H-Source Holdings Inc. is a technology company operating within the healthcare industry through its subsidiary, H-Source, Inc. The Company has developed a transaction platform that provides a private, secure and…

Private Markets

Snapwire

A peer-to-Peer authentic photo marketplace disrupting the $10B commercial photography industry.

Snapchat

Snapchat is the fastest way to share a moment with friends. The mobile app, allows users to not only share photos with friends but also control how long they can…