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Bernanke's Worst Nightmare: Rising Real Interest Rates


What seems to be lost in the monetary debate is that this persistent drop in inflation defies the primary purpose of quantitative easing, which is designed to lower real interest rates.

Rising real interest rates is Bernanke's worst nightmare. Everything he has worked for in academia and implemented in monetary practice is imploding before his very eyes. Contrary to his assertion in 2002, aggregate demand in the real economy has in fact met the limit of monetary policy, rendering QE's impact ineffective and obsolete. The Fed is not only out of ammunition; it is now waving the white flag.

Participants in the equity market obviously do not realize that the QE negative interest rate wind at their back is no longer present. Just as El-Erian implies, they have fallen prey to the illusion of QE stimulus via rising equity prices. In reality, the price of gold -- and more importantly, real interest rates -- are actually reflective of tightening monetary conditions. Perhaps Wednesday's capitulation flush reversal was indicative that the equity market is finally getting the message.

Nevertheless, as real interest rates continue to normalize in the yield curve adjustment process, investors should expect the sizable wedge between financial markets and economic fundamentals that is a product of the mother of all short squeezes to also normalize. That suggests the current state of stable disequilibrium dominated by central banks will soon find the unstable path to equilibrium dominated by the free market.

PCE vs. S&P 500

Twitter: @exantefactor
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