Fed Tapering Is Tightening: The Whole World Has Just Suffered A Credit Shock, Long-Term Borrowing Rates Are Much Higher Across The World, Even As The Global Economy Weakens And The IMF Downgrades Its Forecasts. Is QE4 Coming?

The taper talk was borne out of fear that the Fed’s massive Treasury purchases are destabilising the Financial system by sucking out all the high-quality collateral, leaving too little for the private sector. The TBAC report to the Fed in May made that clear.

So Bernanke started talking about reducing purchases, and the markets started to come apart at the Seams. So he’s spent the last few weeks furiously denying that he said what he said.

Ben is trapped. Tapering will cause the liquidity bubble to burst. Not tapering will cause possibly terminal problems for the banks.

Can the world cope with a trigger-happy Fed?

After weeks of utter confusion, the result of Fed taper talk is clear enough.

Long-term borrowing rates are much higher across the world regardless whether the underlying economies are in any fit condition to absorb this shock.

The rise in 10-year sovereign yields by basis points has been: Japan (25), Germany (35), France (62), UK (63), Norway (63), Australia (66), Korea (66), Spain (70), US (70), Italy (74), Poland (120), Mexico (122), Turkey (131), Brazil (135), and Indonesia (170).

As you can see, the emerging market bloc has suffered the worst hit, especially those countries caught when the tide went out with big current account deficits – the CADs as they are called in the trade.

Basically, the whole world has just suffered a credit shock, even as the global economy weakens and the IMF downgrades its forecasts. What a mess.

A rate rise of 70 basis points or more is nothing short of catastrophic for Italy, Spain, Portugal, all in the grip of nominal GDP contraction, and all at risk of surging debt ratios as the denominator effect does its worst. The ECB must take action immediately to offset this “passive” tightening. It does nothing, paralysed by German central bankers with Austro-liquidationist proclivities.

The emerging market central banks do not all have the luxury of countering the Fed with looser policy. India, Turkey, Brazil, and others are have to tighten pro-cyclically to head off a currency rout. This is how trouble happens.

I am surprised that so many economists and market analysts so blithely accept Ben Bernanke’s assurance that the tapering of bond purchases by the Fed – and ultimately a halt to QE – is not “tightening”. It shows how far monetary analysis has fallen out of fashion in the US and in the City that they fall for such flummery.

“If needed, the Committee would be prepared to employ all of its tools, including an increase the pace of purchases for a time”, he said Bernanke.

Bernanke meant this as a throwaway line to placate the doves. My fear is that QE4 may prove all too necessary. I also fear that getting there will be like pulling teeth.

The taper is lit. The Fed will not swing to the other extreme of yet further QE until we a really are in big trouble. Let us hope that this is not put to the test.


Article Continues Below

Why Some Traders View Fed Tapering as Tightening


Yikes: IMF lowers global economic growth forecasts. (…Wait. Huh?)


Turmoil in the financial markets means wholesale interest rates are rising. We look at the effect on mortgage and savings rate.


Stock Prices Are Outrunning Corporate Profits: When Has This Happened Before?

In a recent article titled “Step Right Up and Test Your Central Banking Skills against the Scariest Economy of All [14],” I encouraged readers to:

[Apply] your economic and policy beliefs to early 1928 conditions, and then [ask] how your decisions might have played out. Imagine you’re [New York Federal Reserve Bank chief] Benjamin Strong, puzzling over a strange brew of rising stock prices, uneven economic recovery, suspect banking practices and unusual strains in Europe’s monetary system.

I argued that global conditions in early 1928 were oddly similar to today, but skewed in a direction that would cause our current policymakers to apply even stronger stimulus than we’ve seen in 2013.

Consider these observations about early 1928:

  • Consumer prices were deflating about 1-2% per year.
  • House prices were stagnating.
  • The unemployment rate was significantly above its low in the previous business cycle.
  • The European monetary system was at risk of coming apart at the seams, due to England’s struggle to maintain its link to gold at an overvalued exchange rate (replace “gold” with “Euro” and “England” with “periphery” and you have today’s conditions in Europe).
  • Germany was near the end of an unsustainable borrowing binge that fueled extravagant local government spending (like China today) and facing near-certain sovereign default (like Japan today).

The analogy suggests to me that today’s Fed is threatening mistakes that aren’t unlike those of the 1920s Fed. But what about the stock market, you ask?

Unfortunately, a few market characteristics fit the late 1920s timeline pretty well. First, P/E multiples, which I touched on in the first article, place today’s stock valuation at levels similar to the latter part of 1928.

july fed article 5 [15]






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