Wednesday, December 18, 2013

On the taper...

Hmm... what's the market going to do if the Fed announces today that it's, at last, ready to cut back on the QE? Depends on whom you talk to. My observation is that there's a fairly even division among the "experts": Half predict a sell-off, half predict a yawn. Haven't heard anyone proffer a buy-the-news scenario (doesn't mean there hasn't been one, I just haven't heard it). So then, because I enjoy playing the contrarian, I'll offer one up here.

It goes like this: Bernanke announces that recent data (he'll expound) suggests that the economy has reached a point where the full $85 billion of monthly asset purchases is no longer essential to the recovery. Therefore, the committee has decided to reduce QE by $10 billion per month (could be $5 billion each of treasuries and mortgage backed securities, or could be all treasuries [they're worried about mortgage rates]). He then proceeds to fall all over himself to promise the markets that the $75 billion will remain firm until they're assured that the recovery stands on firm footing, and/or the economy accelerates at a faster pace. He'll add that should the economy begin to turn south, they'll ramp QE back up so fast your head will spin (although, I doubt he'll say "so fast your head will spin"). Traders then look at one another and say "Hey, we knew they'd taper sooner or later, but $10 billion ain't much, and they're in no hurry to take more than that off the table. And they'll ramp it back up if the economy slows. Dang! We better jump in!" 

So there's my buy-the-news scenario. Sound good? Well, it shouldn't. Here's a better, yet, alas, impossible scenario:

Bernanke announces that the Fed has come to the conclusion that while open-ended QE was a worthwhile experiment, it has come nowhere near delivering the kind of results that would warrant its continuation for another day. Therefore, while the Fed will continue its accommodation on the short-end of the yield curve (now that's possible, in fact, definite), it will entirely suspend its quantitative easing program. While they anticipate a violent reaction in financial markets initially (in fact, bonds and stocks started tanking at the conclusion of his first sentence), they believe it will be a small near-term price to pay to avoid the longer-term ramifications of constant money creation and the resulting mispricing of assets. They hope that halting now, and paying a short-term price, will avert bigger problems (like the 2008 real estate/credit market debacle) down the road.

I'm giving the former (the gist of the speech, not the market reaction) a 50/50 chance of occurring today. Zero chance of the latter...

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