A Global Tsunami, Courtesy of the Fed

Monday, April 4, 2011, 10:04 am
by cmartenson
68 comments

The Fed is in a bind. No matter which way it turns, utter failure is a risk. Putting more money into the system risks no less than the dollar itself. Stopping quantitative easing (QE) risks plunging the economy and financial system into another period of turbulent decline. It looks like the Fed is going to choose the latter.

In a recent report, I made the case that pressure was building on the Fed to end its QE 2 program in June, and that if it did, there would be an enormous rout in the stock, bond, and commodity markets. http://www.chrismartenson.com/blog/coming-rout/53869 That analysis still stands.

This new two-part report will analyze the many competing factors, both for and against, that will determine whether QE 2 really is the end of the Fed's efforts at printing up a recovery, or merely the event that precedes QE 3. The factors are numerous and polarized. On the one hand, there are many signs of economic recovery - the very best that a few trillion can buy - and on the other hand, there's $108/barrel oil and a deeply uncertain future for Japan over the next 3-12 months.

Fed Adopting Tougher Posture

Recently the Fed has trotted out several of its governors to make the case that they are serious about ending QE2. Strangely, they chose Friday and Saturday to go on a publicity tour -- days of the week normally reserved for news that is being buried, not exposed.

I found the following news snippets odd, not just because of their Friday/Saturday timing, but because they are all versions of the story purporting that the Fed is "thinking about tightening."

Fed’s Fisher Says He Backs Ending Central Bank’s Jobs Mandate http://tinyurl.com/3t453z4

March 25, 2011, 2:45 PM EDT By Vivien Lou Chen and Jennifer Ryan March 25 (Bloomberg) -- Federal Reserve Bank of Dallas President Richard W. Fisher said he supports the idea of dropping the central bank’s congressional mandate for achieving full employment.

Fed's Plosser: Funds rate should hit 2.5% in year http://www.marketwatch.com/story/feds-p ... 2011-03-25

March 25, 2011, 12:38 p.m. EDT By Greg Robb WASHINGTON (MarketWatch) - The Federal Reserve should hike interest rates from current range near zero to 2.5% within a year under a plan unveiled Friday by Charles Plosser, the president of the Philadelphia Federal Reserve Bank. Plosser did not give a specific time when this exit would begin but said it would have to start in the "not-too-distant future." In a speech to economists from the monetarist school on Friday, Plosser laid out an aggressive plan where the Fed would sell $125 billion of assets for each 25 basis point increase in the funds rate.

Fed Policy Makers Should Review QE2 Strategy, Bullard Says http://www.bloomberg.com/news/2011-03-2 ... -says.html

March 26, 2011, 9:00 AM EDT By Scott Hamilton March 26 (Bloomberg) -- U.S. Federal Reserve policy makers should review whether to complete a second round of quantitative-easing purchasing due to end in June because of strong U.S. economic data, Federal Reserve Bank of St. Louis President James Bullard said.

All of these are part of a carefully choreographed PR campaign by the Fed to signal to the market that it is serious about ending QE efforts.

A week later, in another Saturday release (April 2, 2011), Bill Dudley offered up perhaps the clearest view of what the Fed is thinking:

Faster-than-expected payroll growth last month shouldn’t alter the U.S. central bank’s plans to buy $600 billion in Treasuries through June to prop up the recovery, said William C. Dudley, president of the Federal Reserve Bank of New York.

“I don’t see any reason to pull back from that yet,â€