It would appear, as uncomfortable as it may be for the mainstream, that the Fed's Bullard has been reading Zero Hedge and realizes the error of his (and his academic friends') ways. In his speech today he noted: "Many of my friends in academia and in financial markets argue that changes in the pace of purchases should not have an important effect in financial markets (and hence would have no eventual effect on the real economy either). However, the empirical evidence from these two episodes provides striking confirmation that changes in the expected pace of purchases act just like conventional monetary policy." In other words, as we said when QE3 was announced, "it's the flow not the stock that matters" and implicitly - as Bullard confirms - tapering asset purchases has the same effect as hiking rates.
As we explained 15 months ago: "The Stock Is Dead, Long Live The Flow" in which we predicted QEternity three months before it was formally announced:
One way of visualizing what this means is to think of a shark which has to be constantly in motion in order to survive. Well, the allegory of Jaws can be applied to liquidity addicted capital markets. Translated simply, it means that it is irrelevant if the Fed's balance sheet is $1 million, $1 trillion or $1,000 quadrillion. A primacy of flow over stock means that UNLESS THE FED IS ACTIVELY ENGAGING IN MONETIZATION AT EVERY GIVEN MOMENT, THE IMPACT FROM EASING DIMINISHES PROGRESSIVELY, ULTIMATELY APPROACHING ZERO AND SUBSEQUENTLY BECOMING NEGATIVE!
All caps aside, what this means is simple: if it is indeed flow that matters (and it is), then Fed intervention can never stop, period. If the stock of a central banks' assets is irrelevant, the Fed can have $1 on the left side of the balance sheet or $1 quadrillion: it does not matter - if the market expects the Fed to stop buying assets tomorrow, then the crash is as good as here. That has precisely been the biggest flaw with the Fed-accepted stock model, per which Bernanke can buy up a few trillion in MBS and the stock market will be flat as a frozen lake. Alas, this is increasingly becoming obvious is not the case. Hence flow.
For monetary theory purists this is equivalent to Martin Luther walking up to the front door of the Marriner Eccles building and nailing his 95 theses: we have now entered the era of the monetary reformation, which incidentally as more and more classical economists follow suit, will throw all of Keynesian and neo-classical economics into a tailspin where virtually every core assumption will have to be reevaluated.
The key phrase from Bullard's conclusion is:
“Financial market reaction to the June and September FOMC meetings provides sharp evidence that changes in the expected pace of asset purchases have conventional monetary policy effects.
Using the pace of purchases as the policy instrument is just as effective as normal monetary policy actions would be in normal times”
Or - in other words:
Tapering Is Tightening
Bullard's Full Speech below: