A First Step On A Tricky Path

September 18, 2013 Current Commentary Comments Off
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Barring a major surprise, we are likely to hear this afternoon that the Federal Reserve has decided to start “tapering” its massive monetary stimulus program – a positive sign that we are getting back on our financial feet, but one that is likely to keep financial markets on edge.

The markets are behaving like an infant that does not want to explore the nourishing potential of solid food, preferring instead to stick with familiarly sweet mother’s milk. This reluctance was on vivid display when the markets opened Monday morning, leaping upward on the news that Lawrence Summers has withdrawn as a candidate to succeed Federal Reserve Chairman Ben Bernanke in January. Summers, a Treasury secretary in the Clinton administration and a former economic adviser to President Obama, has been seen as a skeptic of the Fed’s long-running program of “quantitative easing.” Janet Yellen, the current Fed vice chairman and the most likely alternative to Summers, is one of QE’s biggest proponents.

Even under Bernanke and Yellen, the Fed was expected to announce today that it is scaling back its $85 billion in monthly bond purchases to $75 billion. Until just a few years ago, even that would have been seen as a jaw-dropping intervention in the markets that price and allocate credit. We generally expect Wall Street players to cheer any move by the government to let markets perform their intended function, but that isn’t the case right now. The mere hint by Bernanke last spring that the tapering of easy-money policies might soon begin was enough to send mid- and long-term interest rates up by more than a percentage point over the summer, though rates remain low by historical standards.

Artificially repressed interest rates create financial opportunities for professional traders. They also provide a boost for prices of all sorts of other assets, from stocks to houses to oil wells. I like higher stock prices as much as the next guy, but I want those prices to be supported by healthy corporate earnings rather than monetary helium.

There will not necessarily be another sharp selloff in stocks today if the Fed announces that it has begun its long-awaited tapering as expected. A major move is more likely in the case of a surprise in either direction – a declaration by the Fed that it is holding off to await stronger economic and employment growth, or a fear by markets that tapering will proceed faster than was previously expected.

There is a lot of potential for market tumult over the next few weeks, however. Besides today’s announcement from the Fed’s rate-setting Open Market Committee, we are waiting to see who President Obama will select to succeed Bernanke, how Obama and Congress will work out the federal budget for the fiscal year that begins Oct. 1, and how bad a logjam will develop before Congress inevitably agrees to raise the federal debt ceiling, which threatens to empty the federal checkbook about a month from now. Also, there is the never-ending battle over Obamacare, which has become enmeshed with the debt ceiling and federal budget issues due to efforts by some Republicans to delay or defund the health care law. In the longer term, the Fed must eventually sell off or otherwise whittle down its nearly $4 trillion investment portfolio, a move that could cause disrupt the markets unless it is executed skillfully.

The good news is that the calendar is inexorable. By Halloween or thereabouts, most of these issues will probably be behind us – at least for the moment – while new ones will emerge to take their place. I am not too concerned about the bumps in the road we may encounter in the interim.

As for those who wish vast monetary pump-priming could go on indefinitely, or at least until they can gather their courage to face a world without it, a reminder: You can nourish an infant with mother’s milk, but you can’t raise and sustain a healthy adult with it.


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