Why the Fed may increase the pace of QE3 taper

Philadelphia Fed President Charles Plosser is on the newswires indicating he’d like to see QE3 wound-down at a faster pace.  This news probably shocks and worries many (especially in the investment business). However, I would not be surprised to see an increase in the QE3 taper announced at the March 19 FOMC meeting/press conference. March will likely see the QE3 program reduced from $65B to $55B/month –at the currently expected QE3 taper pace.  Don’t be surprised if Ms. Yellen announces an increase in the monthly taper from $10B to $15B per month. This would allow the QE3 program to be completed as of a final round of purchases in June.


I have long maintained the Fed must avoid a worst case scenario wherein it is still engaged in its last remaining desperate attempt to stop an economic collapse (QE3). Granted, letting some air out of an epic stock market bubble as QE3 is reduced will be detrimental to consumer sentiment and may cause the economy to roll over into a recession. If so, the Fed could apologize, say it did not see a recession coming (supported by BEA estimates of high GDP growth), and then indicate it will come to the rescue once more with another round of QE.


This is a very prickly issue. In order to have QE3 pulled away from the economy without scaring people, the Fed needs Wall St and the economic community to discredit QE3. The rationale being something like “The U.S. economy is strong. We don’t need QE3 anymore. Take the training wheels off — they’re slowing us down.”  Of course this is delusional. But in order to reduce the shock of QE3 being taken away, someone needs to sell the idea it won’t hurt.   Here’s where things get prickly.  What if the “QE3 is not needed anymore” position is successfully sold to the masses?  QE3 would be tapered and all would be well. Escape velocity here we come right?  Almost certainly not.  Given how the U.S. economy has repeatedly fallen out of bed when QE1 & QE2 were ended, I see no reason to expect otherwise for QE3.  With QE3 wound-down and discredited ,what will the Fed do to stop the next recession and stock market collapse?  Another similar-looking QE program would be irrational and would fail. Consider that when QE3 was launched in September 2012, it was a $40B/month printfest. That did not sufficiently stoke the risk-on bet, so in December 2012 QE3 was enlarged to $85B/month.  The next collapse (and it is in its infancy) will either not be stopped by the Fed, or it will –with a truly Krugmanesque price tag — say $150-200B/month.  (I should point out that I don’t sell gold.)


On a related note, do not be surprised to read the ECB is going to launch its own QE printfest. Yes, yes, treaties make it illegal. So look for the ECB to use an intermediary and some investment bank talent to bundle national bonds of various geographies into  securities to accomplish the same objective.  Sound familiar?   Hey, Germany had their elections last year. So Merkel won’t need to oppose it.


 

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Published on February 05, 2014 10:29
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