Last week the Federal Reserve unequivocally ended 'monetary' policy purgatory, in our view. The Fed explicitly stated that it would keep short-term interest rates exceptionally low "at least as long as the unemployment rate remains above 6.5%, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee's 2% longer-run goal, and longer-term inflation expectations continue to be well anchored." They explained their reasoning thusly: "The Committee remains concerned that, without sufficient policy accommodation, economic growth might not be strong enough to generate sustained improvement in labor market conditions. Furthermore, strains in global financial markets continue to pose significant downside risks to the economic outlook. The Committee also anticipates that inflation over the medium term likely would run at or below its 2% objective." Setting expectations by issuing forward guidance, in this case by establishing reaction thresholds, increases in monetary policy transparency in our view and should reduce market uncertainty surrounding eventual policy changes.
For example, the Fed does not currently project inflation to rise above 2.5% over the next several years, as our Weekly Chart shows, but does anticipate unemployment to fall below 6.5% in 2015, at which point it would begin to contemplate raising the federal funds rate. If inflation (expectations) rise above the 2.5% threshold and/or unemployment were to fall below 6.5% before 2015, then markets should expect an earlier exit from the Fed's zero interest rate policy (ZIRP). Alternatively, if unemployment remains stubbornly above 6.5% (and inflation remains contained below 2.5%) then ZIRP could extend beyond 2015. By making interest rate policy conditional upon economic
David Fuller's view I think we know that the long-term consequences of this massive exercise in QE, inaugurated by Mr Bernanke but now widely embraced by central banks in major countries with ballooning debts, will probably be discussed for the duration of this century. The unknown is the extent to which he and QE will be either praised or pilloried. Naturally, I hope it is the former. However, it looks like a massive gamble, in my opinion.
Over a shorter time scale but lengthy in terms of market forecasts, Mr Bernanke deserves some credit for trying to eliminate uncertainty by stating targets for unemployment and inflation, either of which would lead to a change in his QE strategy. Meanwhile, that may be less reassuring than he hopes, given the inevitable array of variable 'surprises' which will be encountered over the next three years or more.
Of course, you and I are more than just interested spectators. The QE policy is hugely influential in terms of markets and also standards of living. Our challenge is to navigate the markets with sufficient success to preserve and hopefully increase our wealth.
So far, QE has been a clear tailwind behind government bonds, thanks to the central banks' own considerable buying of these instruments. Over the last four years QE has also been an effective tailwind behind equities, although they remain more volatile, and it is also helping to support prices for a number of other assets.
Significantly, many companies have been wisely managed, generally enabling them to lower debt levels and raise cash, while also using the increasing pace of technological development to make their businesses more efficient. Consequently, valuations on average have not ballooned. In fact, valuations have actually declined for many successful companies, while their share prices have also risen.
In other words and counterintuitively, if we had only paid attention to economic developments for countries over the last several years, we could be forgiven for guessing that stock markets had serially underperformed. Fortunately, the Fullermoney Collective keeps an interested eye on price charts. The often superior performance of equities relative to economic activity, not least this year, merits our interest and participation. In many instances companies have much better fundamentals than their underlying economies. And the amount of QE has certainly increased.
If I need something new to worry about, I ponder over what happens when the US and other major economies are eventually strong enough for central banks to withdraw their QE stimulus? Meanwhile, a price we are paying for QE is the falling purchasing power of our currencies and a higher cost of living for the expenses we incur on a daily, weekly and monthly basis, relative to the moderately low level of reported inflation.