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Has The Federal Reserve Lost Control?

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    September 25, 2013

    bernanke headacheThe stock decline this week has not only rescinded all the gains from the ‘no-taper’ rally, it pushed the SPX below 1704, which was the level before the Fed issued its market-baffling no taper edict.  My friend Bill King did an excellent job of compiling a series of articles which goes to demonstrate that the Fed itself may be just as confused as to what they should be doing as the market is trying to interpret their “Fed Speak.”

    Economy Not Strong Enough For Fed To Taper

    “The economy still needs the support of a very accommodative monetary policy,” Federal Reserve Bank of New York President William Dudley said in speech…

    For the Fed to cut the pace of bond buying, which he stressed was not a prelude to raising short-term rates, it would need to see real gains in labor markets…he said the rise in borrowing costs that has happened over the past few months is a real impediment to growth. Also holding back growth, Mr. Dudley said, is a “unusually high degree” of drag stemming from the government’s fiscal policies. Tax and spending policies are making it just that much harder for the economy to grow, he said…

    Dudley said the Fed might wait a long time after the unemployment threshold is breached before the Fed begins to raise its federal funds rate target…Dudley lamented that it is “disturbing’ that US income and wealth has become extremely skewed – even though it is the Fed’s easy credit schemes that caused the skewing. This is like Al Capone lamenting alcoholism!

    Fed’s Lockhart:’A Way To Go’ Before Max Emp Objective Achieved

    Despite the progress that has been realized in lowering the unemployment rate from its peak levels, “there’s a way to go before the Fed can claim that the maximum employment objective has been achieved,” Atlanta Federal Reserve President Dennis Lockhart said Monday.

    Lockhart also noted…”the unemployment rate does not fully capture the true underutilization of labor resources today in our economy.”…

    Stocks rallied in the afternoon on Lockhart’s no taper in October comment.

    Fed’s Lockhart: Hard to See Hitting Conditions for October Taper

    “In the short time between now and the October meeting, I don’t think there will be an accumulation of enough evidence to dramatically change the picture” about where the economy now stands, Mr. Lockhart said…

    Dallas Fed President Richard Fisher on Monday said the Fed’s decision to not taper undermined its credibility. Fisher said he tried to persuade the Fed to taper.

    Fisher’s speech: Five Years After Lehman, We Still Have a Big Problem

    I believe that the megabanks are inherently handicapped by their size and scale…Extreme size and complexity have proven to be the enemy of prudence and the source of costly mistakes. Mathematically based risk-management models, while theoretically comforting, have their deficienciesWe learned during the recent crisis just how perilous those deficiencies can be…

    Today, I will simply say that I disagreed with the decision of the committee and argued against it. Here is a direct quote from the summation of my intervention at the table during the policy “go round” when Chairman [Ben] Bernanke called on me to speak on whether or not to taper: “Doing nothing at this meeting would increase uncertainty about the future conduct of policy and call the credibility of our communications into question.” I believe that is exactly what has occurred, though I take no pleasure in saying so.   

    Reuters’ Jamie McGeever: Stephen Jen pulls no punches: Last week was a “fiasco” for Fed “bordering on the arrogant” and “long on book smarts, short on street smarts” [Academics gone wild]

    The Key to Forward Guidance? Don’t Give It, Fischer Says

    The lesson, according to Stanley Fischer, the former head of the Bank of Israel, is the Fed would do better not to telegraph future policy decisions…“You can’t expect the Fed to spell out what it’s going to do,” Mr. Fischer said. “Why? Because it doesn’t know.” He added: “We don’t know what we’ll be doing a year from now. It’s a mistake to try and get too precise.”… [Bingo!]

    Jon Hilsenrath: Yellen Would Bring Tougher Tone to Fed

    … she has clashed with others and left some hard feelings in the wake of those confrontations, according to interviews with more than a dozen current and former staff members and officials who worked with her directly in recent years… “Yellen’s abrasive, intimidating style is probably more suited for a ‘Mad Men’ era as opposed to a modern office environment.”…

    So, what is it?  Is the economy getting stronger and needs less accomodation or is it getting weaker and needs more?  It is quite possible that Guy Haselman of Scotia Bank may well have it correct when he stated, via Zero Hedge, that:

    “Furthermore, the FOMC may be drifting toward having to taper, NOT because it will achieve economic targets, but rather because the risks to financial instability are becoming too great.  At the end of the day, equity prices have to be justified by their earnings and prospective earnings.  It is hard to see where earnings and revenue growth will come from in a slow growing economy.   Monetary policy seems to have done all it can with its limited tools to help economic growth.  Therefore, the risk reward profile for equities – exacerbated by over-exposed asset managers – may trigger asset allocation re-adjustments.

    In addition, markets, risk assets in particular, do not like political dis-unity. The FOMC seem dis-unified; delivery differing messages.  Comments by Dudley and Fisher were not just marginally different, but rather stark contrasts.  Trust in the Fed and in its’ communication strategy have been tarnished.   Markets are now confused as to when, why, and how the Fed will be able to change course.

    Moreover, the Tea Party wing seems to have hijacked the Republican Party into threatening a Government shutdown and possibly even a default.  Sequestration seems alive and well and the economy may be on the verge of a slowdown, rather than acceleration.  Treasuries may need to demand a higher liquidity premium for the moment.  I am confident that when the taper is in full-swing that equities and bonds will drift to lower prices.  However, the immediate trade may require paring risk, and rebalancing portfolios, i.e. stocks down, bonds drifting higher in price (risk off).”

    The potential problem going forward is that the underlying economic and fundamental data is not supportive of asset prices at current levels.  However, the markets have been primarily rising on the back of the Federal Reserve’s ongoing liquidity programs and forward guidance.  If the Fed is indeed losing its ability to support the fantasy that has pushed asset prices to historic highs – the potential reversion to the underlying realities could be quite painful.

    One thing is for sure – there is clearly a rising level of dissent among the ranks of the Fed which could increase market volatility in the months ahead and make it more difficult for the Fed to find a way to successfully exit their program without creating an even bigger issue.

    Images: Flickr (licence attribution)

    About The Author

    Lance Roberts – Host of StreetTalk Live

    After having been in the investing world for more than 25 years from private banking and investment management to private and venture capital; Lance has pretty much “been there and done that” at one point or another. His common sense approach has appealed to audiences for over a decade and continues to grow each and every week.

    Lance is also the Chief Editor of the X-Report, a weekly subscriber based-newsletter that is distributed nationwide. The newsletter covers economic, political and market topics as they relate to the management portfolios. A daily financial blog, audio and video’s also keep members informed of the day’s events and how it impacts your money.

    Lance’s investment strategies and knowledge have been featured on Fox 26, CNBC, Fox Business News and Fox News. He has been quoted by a litany of publications from the Wall Street Journal, Reuters, The Washington Post all the way to TheStreet.com as well as on several of the nation’s biggest financial blogs such as the Pragmatic Capitalist, Zero Hedge and Seeking Alpha.