Bernanke’s Gift (or tempering the taper tantrum)

WASHINGTON - The Federal Reserve on Wednesday slightly downgraded its economic outlook but gave no hint about its plans for its $85 billion-a-month asset purchase program. The statement released after a meeting of the Fed’s policy making committee said that the economy was expanding at a “modest” pace, a change from the “moderate” pace seen in June. The Fed also noted that the rise in mortgage rates was a concern. It also said that persistently low inflation was a risk. There was only one dissent, by Kansas City Fed President Esther George.

This short report from MarketWatch captures the essence of the Fed’s announcement this afternoon, and it would be difficult to conjure how it could have been more dovish. A few weeks ago, after Fed chairman Ben Bernanke raised the spectrum of QE tapering and sent the ten year yield on a tear, I wrote an article titled “Bernanke’s Conundrum” in which I outlined the problem of market-induced rising interest rates, an end result precisely opposite Federal Reserve policy.

Today we get “Bernanke’s Gift” — a colorfully wrapped package for Wall Street from the soon to be departing Fed chairman complete with a big red bow, lots of loud horns and the Federal Reserve board singing in chorus (with the notable exception of Esther “Party Pooper” George). The Fed’s “concern” about rising mortgage rates coupled with the perception of low inflation as a “risk” amount to a back door assurance on the ten year rate and continued quantitative easing. In my view, Bernanke and company did not wish to leave any room whatsoever for ambiguity or having something lost in the translation — a message clearly intended to temper the markets’ recent taper tantrum.

From “Bernanke’s Conundrum” (and still true now):

“Ironically, the stock market, like the bond market, might already be reacting to the new rate reality, while gold’s sudden demise, if indeed caused by the so-called “paring down of quantitative easing,” might have been false. If that is the case, a make-up rally could be in the offing…..in fact it might already have been launched.

In an earlier article, I advised that we should take heed of what the Fed does, not what it says. In a certain sense, as you see in the two graphs below, the Federal Reserve may have already launched QE4 while simultaneously talking about ratcheting monetization down. The two graphs together show cause and effect and tell the real story of what is happening at the Fed. For a while, it wasn’t clear why bank reserve credit (QE) was rising. When you marry that chart to 10-year Treasury maturity rates, the reason becomes quite clear. The Fed is battling the market to keep rates low and the government (along with the rest of the economy) financed at favorable rates.”

In recent days, gold’s rally has been on hold, though the metal is still up over 7% for the month of July. By taking tapering off the table for the time-being, Bernanke might have brought gold off the bench to resume that make-up rally. The question likely to be asked (for which there is unlikely to be an answer) will be: “Well, what happened to tapering?” It is unlikely that we will experience a shortage of commentary or speculation on that score, so buckle your seat belts. The ride could get bumpy.