Why Tapering Will Be Postponed. Again and again…

By Filipe R. Costa

Earlier in the year, Ben Bernanke gave his infamous “forward guidance” speech. He warned the market that he planned to start tapering before the end of 2013. Everyone was certain this meant an announcement at September’s FOMC meeting, so it came as quite the shock when the Fed eventually decided not to act. Were it not for the US shutdown and latest debt ceiling row it is highly likely markets would be rocketing even higher by now as a result.

Fast forward six weeks and the FOMC is set to meet again (tomorrow) and the same questions are raised as to whether or not they will take this opportunity to start withdrawing QE. The consensus is they won’t.

This may sound surprising, given it was only 6 weeks ago that the taper was meant to be a nailed on certainty. After all, five years of monetary and fiscal stimulus are meant to have transferred tangible benefits to the real economy. To an extent this has apparently happened. American unemployment is down from its crisis highs and is edging towards the mythical 7% figure, and which of course is meant to be one of the Fed’s triggers for reducing its bond purchasing programme.

So, with this apparent improvement in data, why remain full steam ahead with QE and keep interest rates at record lows? Why waste monetary ammunition that could be needed if something goes wrong in the future?

The answer to this is probably quite simple. No matter how confident he appears in public, Bernanke understands that the real effects of his monetary policies are almost certainly transitory. As long as the Fed keeps injecting money everything seems OK, but as soon as they stop, the risk is this could bring the economy straight back down again. Genuine wealth isn’t being created (and no, stock market returns do not equal “genuine wealth”!!). All that is happening is that a mirage of wealth is being created by this enormous printing operation.

Apart from its so-called stewardship of the economy, the Fed also has to support the US government. As we’ve pointed out so many times previously, US Federal debt has rocketed from 55% of GDP in 2001 to over 100% today. Such a dramatic increase in borrowing should lead to a movement for reform, but this hasn’t happened. The recent debt ceiling debacle is set to repeat itself over and over, until the politicians are forced to act. And while the Fed continues to fund them, any pressure is removed.

And so, the longer the US government refuses to commit to reduce debt, the more upward pressure is likely to be placed on the yields of US Treasuries. After all a rational investor wouldn’t take AAA rated from a nation with a greater than 100% debt-to-GDP ratio.

However, there is a further twist to this tail… The more pressure that is placed on Treasury yields, then the more pressure is placed on the Fed to continue buying government debt. It is one hell of a vicious circle and while inflation expectations remain benign there is no end in sight.

And so we are left with excuses for why there is no taper. Last month it was because of political uncertainty. This month it will almost certainly be so as to give Yellen a smooth handover. In December perhaps it will be Father Christmas’ fault?!

Even if they do eventually decide to taper, the chances are this will lead to a massive market sell-off. And what happens when markets sell off? Well, of course, the Fed starts buying bonds again. So, prepare yourself. Eventually this charade will have to end, when market forces reassert themselves. When they do the crash will be almighty. At this point we will all be glad of owning some gold.