The Most Important Market No One Is Watching
By Vince Foster Sep 10, 2012 10:15 am
You can't have stronger nominal growth and lower interest rates. When the market begins to discount may be anyone's guess, but it will most certainly show up in the bond market.
Bernanke's nuclear option is a money financed tax cut but that is not feasible in today's political environment. I said it sounds crazy to mail everyone $10,000, but is it really? The output gap is $2t. Instead of easy credit or a money financed tax cut why not just extend cash equity. What's the difference? Take the roughly 140mm tax payers and give them all $10,000 cash instead of credit. Bernanke has already printed $1.6t. What would have happened if instead of giving it to the banks he gave it directly to the consumer? Instead of extending credit through the banking system he should be extending equity. Instead of a credit card it should be a pre-paid debit card.
If the Fed did go nuts and drop money from the skies they would be naïve if they thought it would not elicit a severe market response. The inflationary tail risk would likely manifest itself in an immediate collapse in the US dollar and a corresponding rise in long term interest rates.
This cat-and-mouse beating-around-the-bush game the Fed is playing with the markets is getting very old. If the goal is to trash the dollar and inflate nominal growth anyway the Fed should at least give the money directly to the people who have to bear the consequences. By sticking it in the banking system and on trading books of primary dealers, the Fed is only creating the inflationary market discount which consumers inevitably pay but don't get the money with which to pay it.
Regardless of whether QE III is an implicit target of the output gap or an explicit one, the goal is the same. Bernanke knows employment won't come down with the output gap in place and it doesn't seem he will stop until he closes it. There is no doubt that the inflationary path to close the gap produces a steeper yield curve and higher long-term interest rates.
Bernanke can't have it both ways. He can't have stronger nominal growth and lower interest rates. When the market begins to discount this reality is anyone's guess, but I am certain it will show up in the bond market, and more specifically, in the contract first.
No positions in stocks mentioned.