A smidge or not at all...

I've listened to several commentators the past few days make the optimistic case that interest rates are rising because the economy's gaining, or is about to gain, some real traction. Thus we should be feeling very good about things.

Well, not so fast: Dare I utter those four most dangerous words? Yes, I dare; This Time Is Different. When money has been flowing into bonds for years to the don't-fight-the-Fed (four more dangerous words) tune, we face a situation where the Fed, not the economy, is the bond investor's primary focus---as evidenced by a near doubling (off the bottom) of the 10 year treasury yield in the absence of any semblance of robust growth. I.e., in my view it's more likely taper talk, as opposed to economic prospects, pushing interest rates higher.

Now you'd think the Fed wouldn't cut QE without economic incentive. So with growth estimates having been recently ratcheted down, why then all the taper talk? Well, it could be that the economic incentive this time around isn't growth as much as it is the lack thereof. The Fed may very well be fearing that if they keep pumping they run the risk of inflating the kinds of speculative bubbles that blindside economies when they burst. And, ironically, the bubble they fear this go-round may very well be in the bond market.

But my oh my how they've boxed themselves in. There is no question (in my mind) that---while they'd like to see an orderly unwinding of the bond trade---the Fed is utterly intimidated by the stock market. And the stock market is screaming "don't you dare".

So here's my guess: The Fed either doesn't taper in September, or does so just a smidge---maybe $10 billion---followed immediately by some soothing commentary: "let's see how this goes. If the economy picks up steam we'll taper more---a bit at a time---in the coming months. If it's flat or slows---or if intense political wrangling (it's about to begin) threatens economic growth upsets the stock market---we'll either stand pat at $75 billion or ramp it right back to $85 until things look better." Meaning, for the moment, alas, the Fed's fear of short-term market volatility trumps its fear of growing the next asset bubble.

"The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design." F.A. Hayek