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The Fed Is Trapped, and the Taper Won't Happen Until the Market Tanks


Ben Bernanke and the Fed have lost control of the bond market and are fearful of its impact on stocks.

Now can we please stop with all the taper nonsense? Taper this, taper that. The Fed -- and most media pundits, for that matter -- need to taper their mouths shut. The Fed is never exiting; it is never cutting back on stimulus.

The problem: Now the Fed is in a box and can't get out. Printing money leads to lower rates and helps to re-inflate the real estate market. However, these low rates, and the 10-Year Treasury bond (INDEXNYSEGIS:AXTEN) falling to as low as 1.38%, also help to keep the government's borrowing costs low at a time when it's running huge deficits.

Did you know that despite the national debt being nearly triple what it was in 1996, the nominal interest payments are actually about the same as they are today? This means that despite the far higher national debt, the government pays about the same amount as interest on this debt. If you adjust for inflation, this means that interest payments are actually lower. It's low rates that make this possible. Instead of paying 3% and 7% on 1-year and 10-year Treasury bonds respectively, the government is paying 0.25% and 2.5%. Therefore, a lot of the thinking behind keeping interest rates low is not about benefiting the economy or the housing market, but rather about keeping the government itself solvent.

Now this brings us to the bond market. The reason that the bond market was going down, and why interest rates were going up, was that the Fed was going to taper. Now there is no tapering, and bonds have not rallied that much! Why? Because the Fed is losing control of the bond market; the bond market is telling the Fed that it has printed too much money.

This brings us to the stock market. The S&P 500 (INDEXSP:.INX) and Dow Jones Industrial Average (INDEXDJX:.DJI) broke out to new highs. Part of the reason, I believe, that we got no tapering is because the Fed is somewhat scared of what it would do to the equity markets. Part of its belief is that the re-creation of a wealth effect (even if only a small amount of investors have profited) has trickled down into the economy. Now the Fed is scared to take the punch bowl away -- or better yet, it's scared to confiscate the heroin needle away and take the market off of its juice.

The next meeting is in December; at that time, Bernanke will be one month away from stepping down. The next meeting after that is in March, and Janet Yellen, frontrunner for the Fed chair, will be barely two months into her job. I do not see major shifts with an incoming or outgoing Fed chair.

I actually think that investors should ignore the talk of taper. The Fed is going to print until it can't. Until bond rates spike and the market starts to tank and inflation takes off. Then the market will take the printing press away. However, until then, the Fed is trapped in a box and can't get out.
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