Good-bye bond buying, hello volatility

4 min read

Saying QE is over is a bit like saying a flood is over when the water, up to your chin, stops rising.

The Fed, which as expected pulled the trigger on the final taper on Wednesday, still controls a balance sheet it plans to keep steady at US$4.5trn. And more to the point, though the statement included a bit of upbeat talk about employment, we are now looking at forward guidance of a wait of a “considerable time” before interest rates might actually rise.

There can be little doubt that the US economy is now receiving very intensive support from monetary policy, both through the balance sheet, which remains massive, and interest rates, which remain pinned near the zero lower bound.

If we take the end of the taper as predetermined, and think of how shocking it would have been had they not done this, then really all we are dealing with here is changes in tone and emphasis from the Fed.

To be sure, the statement is slightly more upbeat, both in terms of the labour market and by minimizing fear that inflation will remain below the 2% target. There really isn’t all that much to go on here, and we are going to remain in this situation conceivably for many months, trading off of changes in forward guidance.

The Fed had it both ways in the statement: “In determining how long to maintain this target range, the Committee will assess progress, both realized and expected, toward its objectives of maximum employment and 2% inflation,” the FOMC said in explaining the decision.

Totally unsurprisingly, this cuts both ways in that they may move more quickly or slowly depending on what they experience.

Remember, forward guidance is a promise, but the Janet Yellen who makes the promise is not the same Janet Yellen who will be called on to deliver on it. Besides higher volatility, one worry is that forward guidance loses its efficacy the longer it gets used.

I think it is fair to expect turbulence under these circumstances, almost regardless of what we see by way of economic data, good or bad. The market is going to have a hard time digesting the news of the next six months and should see more sharp moves.

An intervention from the ’maestro’

That brings us to Alan Greenspan, who somehow had the temerity to weigh in on Fed Day with a warning about the troubled times to come.

Hearing from Alan Greenspan on Fed Day, the man who bears as much responsibility as anyone for our current plight, is about as welcome as a Public Service Announcement from the Pied Piper on Mother’s Day.

Greenspan not only said that “Effective demand is dead in the water,” he went on to point out that the bond-buying program boosted asset prices but did little to boost the real economy. The former Fed chairman contrasted the “terrific success” of bond buying in raising asset prices with the way in which it “has not worked” for the real economy.

It is a sad and ironic day when I find myself in full agreement with Alan Greenspan.

It is going to be fearsomely difficult to raise interest rates, much less start to divest the assets on the balance sheet, without disrupting financial markets. Markets will become hypersensitive to Fed tea-leaf reading. That may put the Fed in a tricky situation in regards to the eurozone, which may well be listing into yet another recession.

All of this actually argues for a longer wait for higher rates, which, given the examples in Japan and elsewhere, should not be surprising. Monetary policy in all its various forms only works a bit during these sorts of balance-sheet recessions.

A rate rise may come next June, or in September or later but the volatility will probably arrive well before the actual hike.

(James Saft is a Reuters columnist. The opinions expressed are his own. At the time of publication, Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him atjamessaft@jamessaft.com)

James Saft