On its own, I would not place too much weight on today’s movements in US securities: people have been building up the pricing risk of a change in Fed Strategy for some time and today’s movements reflect only a very miniscule readjustment.
What does concern me, is that while the US economy is indeed operating at a higher level of demand, its rate of growth has slowed down significantly and many headwinds and structural issues remain both domestically and globally. These need to be priced and so does a change in Fed strategy.
I do not think for one minute that the Fed are planning to withdraw stimulus because they believe that their job is done, but because the costs of keeping QE as is, for now, are more likely to outweigh the benefits from here on in, if they have not already done so, which I believe they have. And I am talking asset price risks and the potential impact asset price risks will likely have on the domestic and global economy.
But if a change is as good as a rest, a thought is as good as an act: meaning that an intent to taper and eventually end QE should precipitate volatility as players attempt to move out of assets before they reprice. After all, this is one big game for many….unfortunately.
Perhaps the Fed is comfortable with a certain range of repricing, which of course they must be because the writing is on the wall for some repricing at least.
Perhaps they also feel that the risks of a big repricing of government debt is unlikely, and that the counterbalance to asset price shocks as QE is withdrawn will be a stabilisation in government debt prices and a revaluation of riskier asset pricing – sovereign debt reflects low growth and so do risky asset prices.
Perhaps they also feel, that once the shock has run through the system that people will accept the change and stability will return to all markets, or at least its normal workings, irrespective of risky asset repricing. It is not the level of assets that matters as much as the certainty of a return.
Perhaps they feel that asset price volatility is less likely to feed through to the economy, or at least the financial system and that this road is now effectively closed. Perhaps they feel that the recovery in the housing market underpins the liability side of the balance sheet, and perhaps they no longer want to go out even further on a limb, into deeper space (Star Trek territory).
Perhaps this is another experiment, which of course it is. I think if you think in terms of perhaps, and let your thoughts move along each branch of that thought, there may be enough good reasons to stop QE. I would most certainly like to see Ben’s spatial probability tree.
So what do we have?
We have an assumption that short term asset price volatility will not impact economic growth and that this gives the current “momentum” (?) time to work.
We have an assumption that inflation is not going to be a problem, so any repricing in government debt will be short lived and constrained, so we also have an assumption of certain volatilities.
We have an assumption that growth is slow and that riskier asset prices have gotten ahead of themselves, and given assumption 1, we can afford a repricing with respect to that growth.
And we have an assumption that debt, that impacted the economy and closed in on the heart of the financial system is no longer a problem, because house prices have recovered and key asset/liability risks are now contained.
And we may assume, perhaps, that the Fed wants to divert QE (its stock) into the economy, and perhaps a shock to risky asset pricing may result in rich people spending more, who knows.
And finally, perhaps the Star Ship Enterprise has gone as far as it dares.
But these are not my assumptions. I am guessing as to the Fed’s As. Personally I feel we are already past the point where QE is likely to be of no further benefit to the economy and that the downside risks remain greater in weight and size than upper bounds of potential outcomes.