Throughout 2013, the distortions created by intervention in once-free markets have left many scratching their heads. The interventions have worked - almost faultlessly - but for them to do so has required the suspension of one belief system (economic reality) and the adoption of another - namely, that everything will be OK because ... well, just because. Can the fantasy persist into 2014? Sadly, Grant Williams states "Yes. It most certainly can." Will it continue into 2014? Most likely. Will this new belief system become the new economic reality? Not a chance.
2013 was another year brought to you by the letters Q and E. Quantitative easing spanned the entirety of 2013 and, as was no doubt intended, the market, the public at large, and most certainly just about every single inhabitant of Capitol Hill became so inured to the creation of $85 billion each and every month that the enormity of that policy dissolved from the collective consciousness like early morning mist.
But amidst all the commentary and the debate surrounding QE, most people lost sight of what it actually is — even when we received the much anticipated news in December that there would, in fact, be a Taper after all.
Before we get to the Taper that happened, though, it's important to revisit the one that didn't.
On May 22nd, 2013, Ben Bernanke, in a question and answer session, said the following:
We're trying to make an assessment of whether or not we have seen real and sustainable progress in the labor market outlook. If we see continued improvement and we have confidence that that is going to be sustained, then we could in — in the next few meetings — we could take a step down in our pace of purchases.
The consequences of that statement — and in particular, the last 20 words — reverberated around the financial world and wrought havoc in all sorts of weird and wonderful places. (In a presentation entitled "A Confederacy of Dunces" that I gave to a small group in Spain in late June, after Bernanke's comments, I pointed out the effects of the Taper threat and pinpointed some of those weird and wonderful places.)
The effect Ben's pronouncement on both the S&P 500 and the US 10-year yield were immediately obvious:
The S&P dropped a quick 6%, and 10-year rates (seen inverted in the chart above) spiked from below 2% to 2.6% — a big move.
But some of the other instruments affected by Bernanke's carefully floated idea weren't quite so readily apparent. Nonetheless, they demonstrated just how pernicious and far-reaching the tendrils of QE had grown.
Bernanke also committed the cardinal error of announcing that QE would END once unemployment fell to 7% — a statement he had to back away from, rather embarrassingly, as the slump in the participation rate brought 7% unemployment closer, rather faster than expected:
(WSJ, Dec 6, 2013 ): Back in June, when Fed Chairman Ben Bernanke laid out a tentative timeline for winding down the bond-buying program, he said 7% is where the Fed expected the unemployment rate to be when it ended the purchases. He said central bank officials expected that to occur around mid-2014. Friday's jobs report showed the jobless rate hit that level in November, and the Fed hasn't even started scaling back the program.
The jobless rate for May, the latest data Mr. Bernanke had when he laid out that guide post, stood at 7.6%. Then it fell much more quickly than Fed officials expected, dropping to 7.4% in July and 7.3% in August.
In September, the Fed surprised many market participants and held the quantitative easing program steady. At his press conference after that meeting, Mr. Bernanke made no mention of the 7% guidepost he'd set out a mere three months earlier. When asked about it, he downplayed the importance.
"There is not any magic number that we are shooting for," he said. "We're looking for overall improvement in the labor market."
In short, the trial balloon floated to gauge potential reaction to a $20 bn per month Taper was a disaster, and that meant that when the September FOMC meeting came around, the governors in the voting seats just couldn't bring themselves to pull the trigger.
When the minutes of the October meeting were released in November, it became clear that the FOMC, lessons duly learned, were going to try out the Taper again — perhaps in December:
(Fox Business): Federal Reserve policy makers are still struggling to find the right message for conveying to investors their plans for scaling back their easy-money policies, notes from the Fed's October meeting reveal.
The minutes, released Wednesday, also said members of the policy-setting Federal Open Markets Committee could see the central bank trimming its $85-billion-a-month bondbuying program at "one of its next few meetings."
If at first you don't succeed...
But they had clearly realized that even a $20 bn Taper was going to be taken poorly by the markets, and so the FOMC (and in particular its soon-to-be-retired chairman) needed to pull off a delicate balancing act.
On the one hand, Bernanke would want to leave the Fed with the wind-down of his expansionist policy underway so that he would have the kind of plausible deniability that history has gradually been stripping away from Alan Greenspan. ("Hey, don't blame ME. We were exiting QE when I left office!") On the other hand, though, he wouldn't want to hand Janet Yellen an impossible situation.
"All the goodness of the Taper with no bitter aftertaste!"
... and the markets, after the scares in May and June, LOVED it!!
Errrr ... sorry to spoil the party, but a couple of things here...
Grant Williams' full letter explains why below...