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The Fed To Us; We Stay The Course?

“If we were a company, we would be out of business.”
 
“As a federal official who signs the audit report on the government’s financial statements, it is apparent that our government’s financial condition is far worse than advertised.”
 
–David Walker Former Comptroller General of the United States
 
2013-09-30_1023 Ben Bernanke and the Federal Reserve (the Fed) met on September 17th -18th. On Thursday morning, September 19th, the headline of the Wall Street Journal read, “Fed Stays on Easy-Money Course.” Titles of front page articles read, “Policy Makers Cite Sluggish Economy…”; “Markets Soared On The Report Of Continued Stimulus…”; “…As Fed Officials Dialed Back Their Growth Expectations Between June and September.”
 
Hmmmm. Even though everyone, including me, expected some sort of slowdown of the bond buying program, also known as Qualitative Easing (QE), Ben Bernanke and the Federal Reserve (the Fed) announced last week that it will stay the course and continue spending $85 Billion a month. We all expected the Fed to taper its spending because it made every indication of a slowdown, not only in its last meeting, but in Bernanke’s follow-up speeches as well. By choosing not to taper QE despite these previous indications of an eventual reduction, the Federal Reserve has raised questions about its credibility.
 
Since the Federal Reserve first began to release economic projections three years ago, it has consistently downgraded its outlook. In the latest Federal Open Market Committee (FOMC) meeting, the Fed further lowered its projections for GDP growth in 2013 to an average of 2.15% from an average of 4.15% in its initial projections in January of 2011. The FOMC members are worried about the effects that higher interest rates are currently having on the economy. The question that Cutter Family Finance readers need to ask is, “Where did those higher interest rates come from?” I will tell you. As explained above, the Fed told you, me and the world earlier this year that it was strongly considering tapering its program of purchasing Treasuries and mortgage-backed bonds. As a result, interest rates started marching higher after its last meeting. Let me explain why.
 
In the world of bonds, if the largest purchaser of those bonds, in this case the Fed, were to slow its purchasing of those bonds, it would mean a major bidder, or buyer, is leaving the bond marketplace, right? Well, if the guy who owns the printing press is cranking out $85 billion a month purchasing bonds and decides to leave the marketplace, then those markets would need to find stability. Stability will happen only when the remaining buyers and sellers match up in their interest rate expectations, so rates will be undoubtedly above the current levels. We are all well aware that higher interest rates affect so many parts of the economy. In fact, this is the reason the Fed worked to lower rates in the first place.
 
The Fed opted not to taper the Qualitative Easing because it announced that the economic outlook is weakening. As stated above, the Fed continues to lower its economic forecasts. However, the members of the FOMC, who are extremely intelligent people and who are constantly studying economic data, know one thing – the economy is recovering as well as predicted. A weakening economic forecast would likely result in lower growth from reduced corporate earnings and thus, lower share prices. Lower growth will also keep downward pressure on interest rates. In a nutshell, GDP growth is simply feeble. Five years and trillions of dollars later, the economy is still, well, on life support and its feeding tube is the infamous Qualitative Easing.
 
If the Fed is unclear on what to expect, what do we do? Will the Fed taper? It will. When? Who knows. One thing I do know. The Fed’s decision last week will likely have a couple of economic effects. Interest rates have and will continue to move lower. The other is that we will begin to see increased volatility in the stock markets because the people who are the market makers will continue to position their portfolios based on what the Fed says, but they will now be forced to try to guess whether the Fed will alter its course. This approach resolves nothing. Instead it actually amplifies the exact thing the Fed is trying to fight – uncertainty. And markets hate uncertainty.
 
What is my message to Cutter Family Finance readers? Simply this. We are a bubble economy that historically pops a bubble every 5-6 years with 2008, the housing and credit bubble, being the last. This time the Fed is creating that bubble. It is in volatile times like these that we must pay attention to our investment decisions. Ask yourself, what was my strategy in 2001, 2002, and 2008? What was my result? Has my strategy changed? Should it? In volatile times like these you must not be complacent. If you are pre-retired, retired, or a conservative investor, capital preservation through “pro-active” management is the cornerstone of an effective investment strategy in times like these.
 
In my opinion, although some could argue that the Fed’s plan may have initially made sense, it has run its course. The QE no longer adds any appreciative value to our economy and is artificially lowering interest rates and inflating the markets. In this game of musical chairs, when this bubble pops and the music stops, and it will, I want to make sure our Cutter Family Finance readers have a chair.
 
Be vigilant and stay alert, because you deserve more!
 
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