No Tapering, No Exit Strategy

Most on Wall Street had expected that the Fed would use this June meeting to finally signal that the deceleration of its quantitative easing program is in sight, if not exactly underway. But even these modest expectations have once again been unfulfilled. Although many haven’t yet realized it, the financial markets are stuck in a “Waiting for Godot” era in which the change in policy that all are straining to see, will never in fact arrive. Most fail to grasp the degree to which the “recovery” will stall without the $85 billion per month that the Fed is currently pumping into the economy. Knowing this, the Fed is likely to keep its foot firmly on the accelerator, regardless of the data.

It’s fascinating how the goal posts have moved quickly on the Fed’s playing field. Months ago the conversation focused on the “exit strategy” it would use to unwind the trillions bonds that it has accumulated over the last few years. Despite apparent improvements in the economy, those discussions have given way to the more modest expectations for the “tapering” of QE, which is defined as some type of deceleration of its monthly purchases. I believe that we should really be expecting a “tapering” of the tapering conversations.

In recent months it has been painfully clear that expectations about QE have made a far bigger impact on the stock, bond, and real estate markets than any other economic data points. While some observers have naively described QE as the economy’s “training wheels,” in reality the program is currently our only wheels. But as these particular wheels will eventually take us over a cliff, the Fed should remove them anyway.

Rather than focus on the long term, the Fed is guided by the short term realization that any significant withdrawal of support will cause a steep sell off on Wall Street, a spike in interest rates, and an end to the reflating housing bubble. They are not prepared to tolerate any of these outcomes. As a result I expect that the Fed will continue to pantomime that the Exit Strategy is preparing for a grand entrance even as their time line becomes ever more ambiguous. I believe that the Fed’s next big definitive announcement will be an increase in QE rather than a diminishment.

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