UBS Warns The Fed Is Trapped

Tyler Durden's picture

The Fed seems to be facing two major risks: first, premature tapering disrupting markets and triggering global turmoil across asset classes, thereby threatening the fragile economy recovery; second, delayed tapering further fuelling asset price bubbles, which could burst eventually and do major damage. UBS' Beat Siegenthaler notes the September decision suggested a Fed more worried about the fragile recovery than about the potential for asset bubbles and other longer-term problems associated with extended liquidity injections. Whereas it had originally assumed that a gradual tapering would result in a gradual market reaction, Siegenthaler explains it is now clear that the situation is much more binary; and as such, the hurdles for tapering might be substantially higher than originally thought.

Via UBS,

Central bankers seem more powerful than ever, yet also more divided and confused than for a long time. This may be particularly true for the Fed, as it struggles with how to exit unconventional policies without creating major global market turmoil. In September it shied away from reducing monthly QE purchases, surprising both markets and central bank colleagues around the world. UBS Economics now expects tapering to start in Q1 2014 with the January meeting seen as somewhat more likely than the March meeting. The risks to this call, though, seem almost entirely on the dovish side as a December move would be tantamount to admitting that September was a mistake given the likely lack of decisive data until then. For the dollar, this could keep things difficult for some time.

Looking back...

Why did the Fed decide to hold back in September, deeply puzzling investors who had very widely expected a move, and thereby putting the credibility of its communication strategy at risk? It appears that two arguments were decisive:

First, the recovery was seen as still too fragile to withstand the level of market turmoil that had developed following the taper talk in early summer.


Second, the looming government shutdown and debt ceiling were seen as seriously clouding the fiscal outlook.

Relatively soft economic data since the decision have so far seemed to vindicate the decision as has the subsequent political turmoil in Washington.

However, many observers, particularly in Europe, have been critical on the political aspect of the decision as the FOMC seemed to 'bail out' the politicians and thus risk creating moral hazard. It would seem fair to say that the ECB, for example, would have acted rather differently in similar circumstances. President Draghi's pledge in summer 2012 to do 'whatever it takes' was the exception to the general ECB rule that monetary policy is not there to address structural problems that are the politicians' responsibility. In Frankfurt, nonconventional policies are seen as something to get rid of as soon as possible rather than something to retain as an insurance policy. It was no coincidence that in June this year Draghi said with quite some satisfaction that 'we, unlike other central banks, can gradually downsize our balance sheet without having to take any decisions that would, or could, create volatility'. This, clearly, is not a luxury the Fed has.

...and looking forward

The Fed is facing two major but opposing risks:

first, premature tapering could unleash market turmoil that could threaten a still fragile recovery;


second, delayed tapering could further drive up the cost of the inevitable QE exit.

The emerging market collapse in early summer may have been just a harbinger of what could come once central bank liquidity injections end. Some observers have argued that the market will react in a more relaxed manner to the next round of taper talk as the issues would be familiar. However, this might be too optimistic a view. Equity markets have continued to rally with the S&P reaching new record highs while 'carry' currencies such as the Australian dollar have regained lost ground, even though the advance has since been capped by the October FOMC statement not shutting the window on early tapering. Given that it has generally been a lacklustre year for most investors, the pressure is to jump back into riskier trades and generate some more performance before year end, even if the tail risk of early tapering might continue to loom. In this situation, any piece of weak data and any dovish communication could push tapering expectations further out and lure investors back into risk, thereby increasing the cost of the inevitable exit.

Linear vs. binary

Ideally, the Fed would gradually exit QE as the recovery gradually gains ground. Indeed, this seems to have been the idea behind the tapering talk in early summer, trying to prepare markets for an initial step later in the year. The belief had been that what investors cared about was the stock of QE purchases, i.e. the overall size of the Fed's balance sheet. As it turned out, however, investors seem to care about the flow of QE purchases instead. Or even worse, they seem to hold a binary view, equating the start of tapering to the end of QE, which means positioning does not adapt in linear, but an abrupt way. It therefore does not matter much whether the initial reduction would be $10bn or $20bn as the market would read any move, whatever the number, as a signal that the monetary policy super tanker had started to turn. Or as St. Louis Fed President Bullard put it last week, “changes in the pace of asset purchases have a very similar financial market effect as changes in the policy rate during more normal times”, meaning that any tapering acts very much like a conventional rate hike. “The Committee needs to either convince markets that the two tools are separate, or learn to live with the joint effects of tapering on both the pace of asset purchases and the perception of future policy rates”. Bullard seems to believe that the Fed has to live with the joint effects, which would suggest that the hurdle for tapering is much higher than initially thought.

A clash of central banking traditions

So what should the Fed do? Few central bankers would dispute that there are risks to keeping nonconventional policy measures in place for an extended period of time. In fact, the marginal benefits in terms of the economic impact seem to be declining, while the risks in terms of asset bubbles and other distortions seems to be increasing. Many would also argue that keeping 'emergency measures' in place beyond the actual 'emergency' sends out a bearish signal to investors, keeping confidence down. Central bankers in the European, or more specifically the Bundesbank tradition, would thus argue that given the doubtful benefits of QE together with the increasing longer term risks, the policy should be stopped as soon as possible. The Anglo-Saxon tradition, however, would seem more willing to use asset prices as a tool to support economic activity, and have a higher willingness to accept the risk of bubbles. Indeed, a fear of an asset price shock appears to have been what kept the Fed from taking the plunge in September, and might continue to hold them back for some time. The majority of the FOMC might be seeing propping up asset prices as a second best way to keep sentiment up, in the absence of a convincing economic recovery as the first best solution.

Policy trap

A pessimist might see the Fed facing a lose-lose situation, a veritable policy trap. The only scenario in which a relatively painless escape from the trap would be possible is one in which the economic recovery gains ground and becomes robust relatively quickly. This seems exactly what equity markets are pricing in, i.e. a world in which global economic activity will seamlessly take over from QE as a driver of risky assets. UBS Economics has been drawing a picture that looks fairly close to such a benign scenario, expecting a slow but steady acceleration of global growth over the next two years. Monetary policy accommodation could then be withdrawn gradually, avoiding substantial market turmoil (UBS Global Economic Outlook 2014-2015, 28 October). Viewed from this perspective, the likelihood of the Fed unduly fuelling asset bubbles might thus be considerably higher than the one of prematurely reducing QE and triggering market turmoil, particularly as the track record of the Bernanke Fed, as well as the reputation of incoming Chair Yellen, would suggest that monetary policy in the US will err on the easy side for some time to come. All of this might continue to support risky assets and weigh on the dollar, but also increase the risk of a crash once QE inevitably comes to an end.


The Fed seems to be facing two major risks: first, premature tapering disrupting markets and triggering global turmoil across asset classes, thereby threatening the fragile economy recovery; second, delayed tapering further fuelling asset price bubbles, which could burst eventually and do major damage.

The September decision suggested a Fed more worried about the fragile recovery than about the potential for asset bubbles and other longer term problems associated with extended liquidity injections. Whereas it had originally assumed that a gradual tapering would result in a gradual market reaction, it now appears that the situation is much more binary. If so, the hurdles for tapering might be substantially higher than originally thought.

For investors, the situation is a very challenging one: should they position for a QE world in which risky assets perform well, or for a QE-free world in which risky assets suffer? For the Fed, the ideal scenario might be one where they succeed in keeping the tapering threat alive without actually going there, thereby avoiding both of the above risks. For investors, the resulting low activity and low volatility environment might be challenging.

For the dollar, the future of QE seems crucial. A clean exit sometime next year would be a major positive driver and this is what investors generally appear to position for, or at least believe in. However, the danger may be that these hopes will continue to be disappointed by a risk-averse Fed, which could thus extend the dollar's underperformance for quite some time.

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DaddyO's picture

Glad UBS is finally aware of this startling revelation..

We here at ZH have known this for quite sometime, eh?


RiverRoad's picture

Are they trapped or are they right where they wanna be?  Sure is working for them.

xamax's picture

This puppet (Siegenthaler) certainly needed 1 year to come to these brilliant conclusions, working for one of the most corrupt banks on earth (UBS).

Bay of Pigs's picture

UBS? That's where Jon Stewarts brother Larry Liebowitz worked before becoming COO for the NYSE.

Quite a coincidence that good ol' Stewie gives the bankers a pass when push comes to shove.

surf0766's picture

Meet the fork which leads to the same conclusion. We're fucked.

NakedEconomics's picture

Print, baby, print!

TeamDepends's picture

There seems to be a theme today.  And that theme seems to postulate that time is short, and you need to decide here and now before God and man, whether you are going to grab your ankles or jump through the window when the time comes...

NOTaREALmerican's picture

Well,  if the past is any indication of the future, based on my past I'll be one of those burnt to a crisp when the building burns down.

dirtyfiles's picture

there is no exit for FEDs on this "superhighway" drunken  driving is allowed

NakedEconomics's picture

They always said the machines would eventually take over.  Who would have thought it would be the printing machines.

NOTaREALmerican's picture

Re:  Who would have thought it would be the printing machines.

Yeah really, those Terminator movies just wouldn't have been the same with ON-ald looking like a printing machine.

Awl be printing!  

alien-IQ's picture

Looks like the Fed has two choices:

A) Fuck the rich by pulling the plug on their free heroin.

B) Fuck the poor by devaluing the currency until a loaf of bread cost $20.

Gee...I wonder which way they'll go?

ThisIsBob's picture

He who pays the piper calls the tune.

sixsigma cygnusatratus's picture

UBS must be wrong.  Bernanke clearly said he could change the whole thing in 15 minutes.  He has the big on/off switch.

dirtyfiles's picture

the president has that red button


disabledvet's picture

interesting "forward looking analysis"...could mean anything. the question that needs answering is "did Taper Talk just plunge Europe into a Depression?" Prices are in fact collapsing in Spain and in up France? Germany itself? This whole thing certainly smells of "beggar thy neighbor" but we'll see. General Motors stiffed all the bondholders during their "bailout." talk about "means of production."

NOZZLE's picture

Never a good time to:  Impeach and jail Clitoon, Impeach and jaile ClitoonEtte for letting four guys die in her experiment, impeach and jail CuckHolder for Fast and Furious, Obanga for ObangaCare or Taper, cause it might hurt the market.


NOTaREALmerican's picture


A few minutes after the top 10% - who have owned the government for a few generations now - noticed that the government they owned could prop up their 401k's?

People on here don't see to have any problem with the concept of the banks owning the Fed and the Fed doing what the owners want.

Well, it's the same with anything.  You own something you get to tell "it" what to do.  

thewayitis's picture

Ohh what the fuck......Just keep printing. I want this
bubble to friggin POP. POP bitch POP.

blindman's picture

they have no "get away plan" for the bank (sovereign treasury)
robbery they have undertaken.
Warren Zevon "Poor Poor Pitiful Me" 1987
robbed the craddle, screwed the pooch and
shoplifted the pootie; the fed does it all!
"good night america".
Classic Ron Paul: "We are not supposed to have a slush fund run by o....

eddiebe's picture

The Fed is trapped?? Really?? We, their subjects are the rats in the maze, and I'm sure those in the know at UBS are very aware of the fact.

NOTaREALmerican's picture

Thank god,  enough of the duplicity and morality thread.    Oh, a thread about the fed....

1835jackson's picture

In the 1930's the fed tightened the noose. Again they are loosening the noose only to one day soon tighten it for the LAST time.

blindman's picture

illusions is all the public will ever get, power
realized the dynamics years ago and many times over.
neutralization through misinformation.
"“The CIA owns everyone of any significance in the major media.”
– William Colby, former CIA director

“We’ll know our disinformation program is complete when everything the American public believes is false.”
– William Casey, CIA Director (from first staff meeting, 1981)

“Deception is a state of mind and the mind of the State.”
– James Angleton, head of CIA counter intelligence from 1954-1974

“I never would have agreed to the formulation of the Central Intelligence Agency back in forty-seven, if I had known it would become the American Gestapo.”
– Harry S. Truman" ...
LAX Hoax - No HD Surveillance Camera footage released and Ciancia
this is why we are all just doomed idiots, everyone.
the unit of measure is a poof illusion and fraud,
how does one become trapped by such a thing?
anyway poems *t

22winmag's picture

BREAKING NEWS: The pot calls the kettle black.

29.5 hours's picture



From way outside looking in, I don't understand why there should be much agony in the Fed over the taper / continue QE debate. Given the sums involved already, it seems the result of any such debate is moot. They are so far in, unwinding those sums so hellish, they may as well continue until all agency of change and control is out of their hands.

The Federal Reserve truly is trapped--and that's true even if lying bankers say it too.





Brazen Heist's picture

I see bubbles everywhere. Not just in the US but also in the UK and Australia.

g'kar's picture

"I see bubbles everywhere."


That sounds like a new M. Night Shyamalan movie title.



MisterMousePotato's picture

Yes, but will it be a musical or a Chucky kinda flick?

NDXTrader's picture

The Fed is a private corporation. Why would they purposefully devalue trillions of dollars of their own assets? Especially when there doesn't seem to be any pressure to do so. In fact, Draghi and Abe seem to be giving them every green light to keep the ball rolling

NDXTrader's picture

Not to mention that after the December meeting Bernanke is off scott free. Why would he suddenly play Scrooge after being Santa for so long. And I think everyone knows Yellen ain't tapering anything

Solarman's picture

They are not.  They are stealing real/physical assets, and pushing inflation to keep their debt slaves from defaulting en mass, thus causing a loss.  The Fed now owns virtually all the assets in this country.  Five banks, 100 families own us, and they still baffle everyone with bullshit with these distractions called policy moves.


This is why they are terrified of deflation.  Deflation is the friend of the poor.


This was theft by counterfeiting.


As an aside, the grammar in the first paragragh looks like a translation program's work.  Pretty poor.

gatorengineer's picture

Abenomics has shown that the fed can go lots and lots and lots further... Until they cant.  I predict a pathetic Jobs number tommorrow and and a 3 percent rip....  Fuelled by some of the shorts who boarded the bus today..



NDXTrader's picture

I definitely see that as well. They sucked some people in today to add a little fuel. I'm more than happy to play the downside when it comes but lets not forget they are pumping $85 bill a month for at least the next 6 weeks. $85 billion can be leveraged to infinity

kedi's picture

I disagree to a large extent. I take into account the balance sheet in Japan being held in much larger part by it's citizens. And then the character of it's citizens and their ability to accept and work through harsh circumstances. US is looking at collapse of system and citizens going apeshit. Japan will fair better.


kedi's picture

To non explosively, return to a more sensible, fair, real course. The fed, politicians and a lot of other players are going to have to figure out a very complex transition period plan, to eventually get back to a properly regulated, free market. To be the least disruptive and somewhat fair to most of the participants/victims/players of the past while's fiscal and regulatory idiotic regime. It will require a number of grandfathered situations. Set to taper back into a reality over varying periods and at varying points. So the plus and minus of them is absorbed and dealt with over time. It took time to screw it up in steps. It takes time to straighten it out in steps. Sadly. There are few in any positions of power who will take the time, work, and cooperation to construct such a plan. Few who have the knowledge, brains and guts to do it. Instead, it will break. And again, the current crop of the powers that be, have not earned that power through knowledge, brains, guts, to make the breaking any better to survive.

NDXTrader's picture

You speak sense my friend. That's why it will never happen

exartizo's picture

hmmmm.... methinks the dumbass analysts at UBS should be reading ZH.

..we've all known about the Fed's Folly now for a few years...

What's up with that UBS?

What are you paying those analysts for anyway?

g'kar's picture

Since I'm not in the markets, I say sell. It could be more fun to watch.

1512's picture

Please. The markets aren't even responding to QE. Just a bunch people trying to get a bunch of other people to think they are so they can get some big ass trades on.

dunce's picture

QE1, 2, 3, 4 and ZIRP have failed because they have no effect on the real problem which is too much govt. spending. By the same token tapering no matter how slow will not be effective at getting back to any normal economy. They might as well throw virgins into a volcano.

polo007's picture

Today, a small group of central bank chiefs can meet in private and wield unprecedented power over global markets, economies, and wealth distribution. They are held accountable to the ruling politicians that in most cases have no respect for the principle of sound money. Instead, in Europe, the UK, Japan, the US, and elsewhere, central bankers have become intricately linked to monetizing government debts, and financing the expansion of the welfare state. As such, disciplined and independent central banking, a cornerstone to any hope for sound money and credit, has been relegated to the dustbin of history.

Central banking, - ostensibly designed to combat high levels of inflation and promote economic growth, while overseeing the stability of the banking industry, has instead, morphed into technocratic planning boards that are constantly involved in rigging the value of the financial markets. Their principal modus of operandi is to encourage risk taking in the local stock markets, through massive injections of ultra-cheap liquidity. However, the result isn't better economic conditions, but rather the expansion of massive bubbles in various financial markets. In turn, central bankers have widened the wealth gap between the owners of equities, and the rest of the struggling population whose wages are sliding backwards, and is increasingly seeking out assistance through welfare programs.

Historically, the value of the stock market reflected the dynamics of the local economy, and would influence the social mood of the populace. A stock market that is booming would signal an up-and-coming economy that would be followed by increased business investment and the creation of good paying jobs. Rising share prices boost the fortunes of about 10% of households in the country, and triggers a greater propensity to spend for goods and services - otherwise known as the "trickle down" effect. Therefore, keeping a constant vigil on the behavior of the stock market, - has become the raison d'être of central banks.

In earlier times, stocks traded on the local stock exchange used to track or even anticipate the nation's business cycle. But that reliable role as a leading indicator began to seriously break down after the financial crisis of 2008. Since then, because of the hallucinogenic effects of "quantitative easing" (QE), - stock markets are no longer reflections of the health of the local economies or forecasting mechanisms of the business cycles. Instead, they are just slices of ownership in specific companies that are unreliable gauges of anything but the underlying strength of the companies they represent, their dividend payments and buybacks, and the schizophrenic mind-set of the traders who buy and sell the shares.

justsayin2u's picture

These geniuses just figured this out.  The real issue is that governments are all spending like drunken sailors, raping their citizen's wealth, racking up huge defecits. all justified by Keynes in the spirit of "GDP" and "multiplier" blah blah blah.  The reserve banks are boxed in more and more by the inability to raise interest rates since that will crush government spending and lead to governments "borrowing" money just to pay interest on the debt we already have.  Countries are trapped - politiciansall know it and are afraid to own up to the mess they have created.  The big media cover up for the free spenders in government.  The solution = currency debasement and hyperinflation - yeah - thats the ticket - the politicians are happy to ruin everyone so they don't have to face up to their ruin they have created.  And the american people keep electing the fools cause now more than 50% of americans are dependent on big govvy for some part of their income.  Does anyone see a problem here????   Hello  Hello  anyone???  Buehler???  Buehler>????

PowerPlayer's picture

I laugh at all these people that think the Fed will taper in December. The markets may perform ok if the Fed begins tapering with a backdrop of strong economic growth, but if the Fed tapers because they are worried about the size of the balance sheet and before the economy is showing strong signs of growth the markets will collapse.

DOGGONE's picture

See here & don't miss table at bottom.