The Independent Investor: The Fed Turns Off the Spigot

The Federal Reserve Bank announced an end to their latest quantitative stimulus program on Wednesday. The markets worldwide sold off on Thursday. Was it just a coincidence?

 

It was not as if their announcement was unexpected. The Fed has been winding down its $85 billion a month purchases of bonds and mortgage-backed securities since the beginning of the year. Each month they have pared back $10 billion/month incremental purchases.

 

June's policy meeting confirmed that the last purchases would end in October.

Some investors were relieved, while others were concerned. Many believe that the longer the Fed's program continues the less impact it will have. Others disagree. That is nothing new, since, from the outset, the entire Quantitative Easing (QE) program has been mired in controversy. 

 

The initial round of QE in 2008 was intended to prevent the economy from plunging into a second Great Depression. The Fed succeeded in that desperate bid and followed the first QE with successive bouts of stimulus in 2010, 2011 and 2012.

 

Unfortunately, its goal — to jump-start the economy and return it to a healthy growth rate — has had, at best, mixed results. While unemployment has fallen from almost 10 percent to 6.1 percent in June, the economy has remained mired in a slow-growth recovery. At the same time, this unprecedented meddling in the economy has resulted in a number of distortions, some good and some not so good.

 

Keeping interest rates low was supposed to convince American investors to sell their low-yielding, safe-haven U.S. Treasury bonds and buy riskier assets such as stocks and corporate bonds. The hope was that would in turn spur an increase in lending, consumer spending and investment. Very little of that actually happened. Investors and banks alike either remained in cash or their Treasury bonds.

 

It was the stock market and rampant speculation that has been the main beneficiary of the Fed's efforts. Some argue that the gains in the stock market have only benefited a tiny portion of the population (the One Percent) and there has been precious little "Trickle Down" impact on the economy.

 

Although the unemployment rate has declined, economists argue that the numbers are deceiving. Many After years of attempting to find a job, many people have simply dropped out of the rolls thereby reducing the unemployment rate. The data also indicate that a growing number of these gains are low-paying, part-time jobs, something the Labor Department's numbers fail to account for within these trends.

 

Then there are the risks. Potential inflation heads that list. Contrary to those who have been predicting hyperinflation, the numbers do not bear that out. For the last two years inflation has been running below the Fed's target rate of 2 percent.  

 

However, that could change. If, at some point, banks begin to lend those trillions of dollars, instead of speculate with it, if corporations begin to invest in plant and equipment rather than buy back their stock or someone else's, then the story could change.

 

The multiplier effect of money begins to come into play. That is when the dollar I lend to you is used to buy a widget or two, in turn, the widget seller turns around and uses that same dollar to pay my neighbor to make more widgets and so on and so on. In that way one dollar becomes many more. That's what causes inflation. We haven’t gotten to that point yet. And the Fed says they will raise rates when and if that happens. 

 

Some say all the Fed has done is cause a gigantic bubble in financial assets. The Fed says no, markets, in their opinion, are simply fairly valued. No one, including the Fed, really knows for sure. In many ways this entire QE program has been a grand experiment and the final outcome has yet to be written.

 

So back to the stock market, if you trace the behavior of markets through these various QE programs, one thing stands out. In every instance, once investors understood that the QE program was ending, the stock market declined.  One wonders if this will happen again this time.

 

Bill Schmick is registered as an investment adviser representative with Berkshire Money Management. Bill’s forecasts and opinions are purely his own. None of the information presented here should be construed as an endorsement of BMM or a solicitation to become a client of BMM. Direct inquires to Bill at 1-888-232-6072 (toll free) or email him at Bill@afewdollarsmore.com.