The first warning shot across the bow of the markets from the Fed came on Wednesday. Fed Chair Bernanke appeared before Congress on Wednesday and finally signaled that, depending on the data of course, the Fed could start slowing the rate of QE. The markets immediately reversed and on Thursday the Japanese market, which has been on an absolute tear, fell 7%. Whether or not this will lead to the long-awaited correction remains to be seen. The markets have been on a tear due in a large part to the fear investors have of missing out. That hasn’t gone away yet, but at the same time the pace of the advance was becoming unsustainable (Japan has been an extreme example) and a pause would do some good. Fundamentally the factors that have been pushing the market up remain in place and so any pullback could remain shallow.
Economic data continues to show modest growth with hopes of increasing slowly as the year progresses. The economy is getting to the end of the deleveraging process and with the Fed’s tip of the hat, we have now officially entered the mode that if the economic figures get stronger the Fed will conversely reign in QE. Overall, that is a good thing and long overdue. As I have said for some time it is unfortunate that just as the economy starts to hit “escape velocity” the Fed will have to actually or potentially pull back on QE. That keeps economic growth in the slow growth mode. That’s the price of QE at the least and it’s a shame in my opinion. We would be better off if years ago we took more of the pain upfront rather than shackling ourselves with the pains of unraveling QE now.
This was mostly a psychological move, a sort of trial balloon, by the Fed to see how markets would react. They will still be providing massive amounts of QE and will be very slow in pulling back. They will still risk inflation over letting the economy slip. In a practical sense their actions are nothing more than pushing on a string. Markets are all about future expectations though and the beginning of the end of QE could be upon us. Going forward, the Fed will now have to play a skilled balancing act in managing expectations about unwinding it massive balance sheet. No easy task to say the least.
Equities still remain the place to be but the easy money has been made and it could now be a choppier ride going forward.
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