Don't Count On More QE Stimulus, The Fed Is Likely Retiring It

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by Wealthion
Wednesday, Oct 05, 2022 - 1:44

Adam Taggart of Wealthion sat down with journalist Pedro da Costa to get his latest policy outlook on the world's most important central bank:

Here are Adam's key takeaways from the interview:

We’re at a dangerous and pivotal moment when the central bank tightening gets ever closer to possibly triggering serious financial instability. The desperate bond market rescue by the BoE last week is a good example of this.

The Fed realizes that it’s ‘behind the curve’ and now is playing for its very credibility (as Alf Peccatiello has said) and Pedro believes it’s more resolute than the market realizes to doing ‘whatever it takes’ to tame inflation. That means job losses, recession & failure of weaker businesses are acceptable “collateral damage” in its pursuit.

Given its past track record, given the crudeness of its tools & given the severity of the challenge, the Fed is unlikely to gracefully manage the outcome of bringing inflation under control. A financial instability episode may very well help bring inflation down — but that’s not something to root for.

Also, given the unprecedented level of debt now, the Fed has much less wiggle room than it has had in the past. We may already have passed the maximum tolerable level of Fed Funds Rate for the system. And given how fast rates have been rising (the fastest in history), the likelihood we send the system into shock is probable.

But the policymakers are less concerned — right now — about these systemic instability risks. They are laser-focused on inflation and fear doing “too little” to get it under control. They’s willing to suffer some “breakage” if necessary to get a win on inflation.

The Fed et al are chasing lagging indicators. They may be doing this intentionally, as they provide justification for the aggressive moves the Fed is taking now (because, like payrolls, they show the economy is still ‘robust’).

The risk here is that when the Fed decides to pause/pivot, there will still be waves of tightening measures that continue to roll in given the time delay (~9 months?) between Fed action and when the impact is seen in the economy.

Pedro thinks the Fed is trying wean the markets off of their assumption of a “Fed put”. It realizes that it has created a monster in encouraging too many players to chase excessive risk assuming the Fed will always step in to protect them from losses. In fact, Pedro thinks that QE as a stimulant may get retired from the Fed toolbox. It will likely still be used as a short-term emergency measure in a true crisis. But the days of tens of $billions in asset purchases per month may be over, even if the Fed “pivots”.

Pedro thinks that not only will Powell tighten higher for longer, but that if/when he pivots it will be due to serious financial instability. So those waiting for a pivot to go “all in” on the markets expecting prices to rocket higher — he thinks this is a risky gamble. If a pivot happens under these conditions, it will likely be because scary damage is happening which should NOT be bullish for assets.

UK a great recent example of the financial instability threats we’re talking about. Open question now is whether the UK can continue its inflation-fighting measures. It may have just hit the limit — it may not be able to tighten any further without breaking its bond/gilt market.

Fiscal policy is increasingly a wildcard now, too. It’s what served as the trigger in the UK. We could see the same here, where Congress wants to stimulate while the Fed wants to tighten — but Pedro not too worried given that we’ll likely have a divided Congress post the Nov elections.

Pedro is concerned that the destabilizing impact of a sizable correction in the housing market is under-appreciated right now. Yes, banks may be better capitalized than they were in 2008, but the drag on consumer spending and the knock-on effects of many related industries could be much more substantial than folks currently are prepared for.

While not a financial advisor, Pedro thinks this a “risk off” time for investors & those pinning their hopes on a Fed pivot setting off a new bullish run for stocks are likely setting themselves up for disappointment.

The US dollar is likely to remain strong for a good time from here. It has a lot of unique advantages that aren’t going to change anytime soon. Relative to other major currencies (e.g., yen, euro, pound), it’s in a much better position.

Somewhat surprisingly, Pedro reports that the policymakers he talks with are lukewarm or outright skeptical of CBDCs. He thinks it will be a long time, maybe never, that the US issues its own.

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