So after surprising everyone with plans to taper its quantitative easing programme several months ago, the Fed has shocked everyone again by doing nothing of the sort.
This ‘as you were’ approach from the Fed may have been unexpected, but is understandable: a sharp rise in mid- and long-term borrowing costs has seen 30-year mortgage rates jump by more than a full percentage point since May, from 3.4% to 4.5%. This is beginning to create a slowdown in the housing market, which, given how closely it is tied to the wider economy, is the last thing Fed chairman Ben Bernanke wants to be remembered for when he leaves office next year.
This didn’t stop the central bank coming in for some harsh criticism from some quarters however, with many claiming the Fed would rue the decision to sit on its hands.
“Bubble concerns could return, but the Fed would only have itself to blame: it has missed a perfect opportunity to start moving policy toward the exit,” warned Schroders chief economist Keith Wade, while Old Mutual Global Investors head of fixed income Stewart Cowley went even further: “This nothing to cheer about; it will make the eventual day of reckoning even worse for the bond and equity markets. “I suspect the euphoria won’t last long; we are now engaged in the biggest game of ‘chicken’ the world has ever seen – investing in US government bonds has become the equivalent of running into the middle of the motorway to pick up pennies.”
You can’t blame the markets for expecting the move; the Fed’s communication back in June suggested as much and the printing presses need to start winding down eventually. However, if anything this entire episode shows how dependent markets are on the Fed: just the mentioning of tapering back in June caused market interest rates to rise in a way the bank had perhaps not anticipated.
If merely raising the subject had already brought about a considerable tightening of money conditions, the Fed may have felt its work – for the time being at least – had been done.
As Keynes famously said: “When the facts change, I change my mind. What do you do, sir?” The reasons for the Fed’s change of mind are there for all to see, but sooner or later it will have to bite the bullet and turn off the supply of cheap money. The longer it goes on feeding the addiction of the markets, the harder it will be to go cold turkey.
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