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What If the Fed Does Taper QE? 8 Possible Scenarios

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A look at the Fed's possible coming actions and the way they could affect the markets.

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In previous articles and market overview reports, my firm discussed the unique macroeconomic position of gold (gold is a system hedge). The main conclusion was that gold is something else than its highly touted reputation as an inflation hedge. This realization is crucial for any gold investment decisions. Actually, when it comes to gold and the case for it or against it, there are many conflicting arguments. On one hand, we hear stories about the threat of inflation and a sharp rise of overall prices, therefore we're told that one should invest in this shiny asset. We also hear about credit deflation, banks in trouble, and financial markets that are not in great shape, making gold a good alternative. Having been fed all kinds of information, one can have trouble inferring what to do in various scenarios.

As always, there are many ways in which the situation can develop, and in today's article we will focus on what's probably the most important factor that will, to a great extent, determine what will happen in the coming months -- not just in the precious metals market, but also in bonds, stocks, and real estate markets.

Yes, you guessed correctly -- we are going to discuss the Fed's possible actions and the likely way this could affect the markets. Will we actually see any form of tapering or will we just hear about it? If so how will remarks made by the Fed impact actual events? As you know, very often what Ben Bernanke or some other Fed official says can ignite large price moves. So, for the analysis to be complete, we should focus not only on what happens, but also on how it is announced.

In the following part of this article we will discuss what's likely to happen if the Fed does indeed taper the QE program.

Based on the possible combinations, we created eight scenarios, and we will discuss how each of the markets (gold, stocks, bonds, real estate) could perform in each of them. We also explain which are the most and least likely. If they play out in the future you will already know what to expect in the following weeks/months.

The involvement of the Fed in buying assets makes it the most important player in the financial market. Over $3.5 trillion amounts to 23% of the American GDP (compare that to "savings," which are almost two times less than that). There are "rumors" about the Federal Reserve System's possible stepping back from its policy of quantitative easing. The rumors came from Bernanke's speech, and were slightly present in Fed's minutes from July 30-31 (the minutes were published on the August 21. They register discussions that take place during Federal Open Market Committee meetings).

The so-called tapering of the Fed would mean a significant slowdown of the programs (which lead to an increase in the assets holdings). Many observers argued that tapering is supposed to start before the end of 2013, September being the likely candidate. The minutes do not confirm this, at least not strongly. We can read that "almost all Committee members agreed that a change in the purchase program was not yet appropriate." There was only one mildly dissenting voice about some improvement in the labor market as a reason for the Committee to offer an explicit statement about asset purchase reduction in the "near future." A few members responded that patience is needed in order to carefully evaluate the economic data. A few others responded that the plan was already articulated (although not very strongly), and that the programs will be reduced.

In conclusion the Fed decided to keep the programs floating: They buy $40 billion of mortgage backed securities and $45 billion of Treasuries each month in order to bid the prices of both (and keep the returns low). Moreover, the interest rate is supposed to stay at the current low level of 0.25% as long as the unemployment rate stays below 6.5%, and the official inflation rate is not half a percentage point higher than the main policy goal of 2%.
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