Apr 24

It’s the Final Countdown at the Fed


Will interest rates continue their meek rise, aided and abetted by QE tapering at the Fed?  Or, will they fall reflecting the lack of inflation, a sluggish economy and continued QE at the Fed?

These and other questions may be answered when the Fed meets this week to discuss the Final Countdown.

By the Final Countdown, of course, I do not refer to the famous riff played by the 1980’s band Europe.  Nor, do I refer to the theme used by Gob Bluth during his illusion act in the revived comedy classic, Arrested Development.  And, of course, I do not refer to the 1980 movie where the USS Nimitz travels back in time to 1941 Pearl Harbor.

However, I do mean the Final Countdown to the end of QE that so pre-occupies financial markets worldwide.  The main fear in the markets is that the minute the Fed even hints at tapering (reducing purchases of US Treasuries and Agency RMBS), we will see a scare akin to 1994.

A trip back in time, without the help of the USS Nimitz, would reveal that from February, 1994 to February, 1995, the Fed increased its short term benchmark rate 300 basis points and the bond market reacted by increasing yields on the 30-year Treasury (that was the bond market benchmark, back in those days) by over 200 basis points.  Are we about to see a repeat?

Reread that last paragraph, and you can see that market participants are grappling for straws.  The Fed is not about to raise the fed funds rate by 300 basis points any time soon.

However, they will undoubtedly have to start reducing the size of their purchases of US Treasuries.

Why?  There will be less of that government borrowing going on, now that the year’s deficit is expected to fall from the $1 trillion+ level to something north of $600 billion.  Still, that is lots of government borrowing to stoke the political posturing nonsense in D.C., instead of, perish the thought, reasoned discourse.

With fewer newly minted US Treasuries to buy, unless the Fed truly wants to corner the market on government debt (many would call that monetizing the debt), they have to taper (reduce) those purchases in a similar manner.

As for the Final Countdown to the end of QE, Chairman Ben, much like Gob Bluth, has been playing the same song for some time.

Unless inflation rears its ugly head (not an issue at present), the employment part of the Fed’s mandate will call the tune.  Cutting through the cacophony coming from the financial press is sometimes as difficult as getting that band Europe’s riff out of one’s head.  But, let’s try and do that by going to the FRB Atlanta unemployment calculator.  Plug in your own assumptions, or use what the FRB has, and it looks like we are about 22 months from reaching the goal of a 6.5% unemployment rate, assuming the US economy keeps adding about 175,000 jobs per month (same as last month).  That is the springtime of 2015.

Of course, a net 175,000 jobs is a big number to consistently add every month, but this did occur in a few month during the last recovery (2001-2007).  So, the complete end of QE will have to wait for a while, giving the nervous nellies in the press lots to talk about.

But, what about the other Final Countdown, that may be first and foremost in the Chairman’s mind?   The number of months to the end of Chairman Ben’s term.   On January 31, 2014, his term will end and most sentient beings who obsess over these things are expecting the Chairman to step down and be replaced by someone with similar feelings about QE.

So, how momentous will the announcements from this week’s Fed meetings and subsequent press conference by Chairman Ben be?  Not very, but afterwards, we will all have time to recalibrate the various Final Countdowns.   Over to you, Europe…the band that is.

As for the continent, well they really do have their own Final Countdowns to worry about…

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