Hey Bernanke, What Are You So Afraid Of?

Ben BernankePrior to yesterday’s Fed statement and Ben Bernanke press conference, CNBC’s on-air editor Rick Santelli had the following choice words for the Fed Chairman (words as stated and not edited):

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“And the one question I want to ask Ben is, ‘Ben, what are you afraid of?’ I want to know what you’re afraid of. CNBC, all the channels out there that cover business, we have person after person after person, buy side, sell side, upside, downside, ‘How’s the economy?’ ‘Economy’s great.’ ‘What about stocks?’ ‘You gotta buy them.’ ‘What if they break?’ ‘You gotta buy the dips.’ What’s wrong with the economy? I don’t hear these people saying anything’s wrong with the economy. So what’s wrong, Ben? Why can’t we get out of crisis management mode?”

Santelli continued:

“So why can’t we take away the QE? I don’t get it. What are we afraid of? Do we have a Fed that operates like a day trader? Where every little gyration in the market, every 10 minutes, is all that matters. If you pull it away, and the stock market goes down, where’s it say in the Constitution that some form of the government has to guarantee stocks go up or guarantee that you have a house? They don’t. Where have we gone off the rails? Enough is enough . . . I would like one reporter to say, ‘Mr. Chairman, what are you afraid of in the U.S. economy?’”

Santelli concluded:

“In the end, they’re gonna have to deal with reality. And the longer you put it off, think being a parent, the worse the consequences are.”

What are Bernanke and the Fed afraid of? I think Santelli and most of Wall Street know the answer to this question. Bernanke and the Fed are well aware that a massive distortion in asset prices has occurred as a result of QE and that if the Fed stops QE, asset prices across various parts of the financial markets are likely to fall. The Fed doesn’t want that to happen because any hope of creating the inflation it wants to create rests on rising asset prices. Not only that, but far too many investors have figured out that far too many other investors have been buying stocks because of the “Bernanke Put.” That, in turn, puts the Fed in a bind because any tightening of monetary policy would eliminate the reason for which so many financial market participants are buying stocks.

Furthermore, the Fed knows that the so-called “Main Street” economy is not recovering with any type of vigor. It also knows that wage growth remains tepid and that the quality of jobs being created are not such as to engender robust consumer spending across various income levels (not just at the top). In addition to all this, the Fed must grapple with a Federal government that appears unwilling to fix the long term fiscal challenges the U.S. faces not only because it is in no one’s political interest to make the tough decisions, but perhaps also because the bond market has yet to force policy makers’ hands. I have a hunch that one of the reasons the Fed is reluctant to tighten monetary policy is because the Fed is trying to buy time for policy makers in Washington, D.C. to deal with the nation’s long term fiscal challenges. The Fed doesn’t want higher rates until those challenges are dealt with, but policy makers seem reluctant to deal with those challenges until interest rates head higher, thereby allowing them the political leeway to make unpopular decisions.

Of course, the Fed will likely never admit to all this because it doesn’t want to destroy the confidence of those who still believe in the Fed’s ability to cure all economic ills. And so ultra-easy monetary conditions will continue for a long time as QE does nothing to cure the problems on “Main Street’s” economy and does nothing to speed up the process of politicians addressing serious future fiscal challenges. It may, however, continue to prop up the stock market and induce behaviors that are helping to drive housing prices higher. Although I suspect that will eventually reverse course once enough time has passed without a self-sustaining recovery, thereby causing confidence in the Fed’s powers to wane.

For bond investors, a continued multiyear period of a zero-interest-rate policy (regardless of whether QE is on or off) will give them an opportunity to continue to collect coupons and ride the yield curve—a yield curve that will remain steep so long as the Fed doesn’t raise short-term rates. And that won’t happen for a very long time. Don’t forget the amount of hysteria we are currently experiencing regarding the eventual tapering of QE. The markets aren’t even prepared to handle tapering, let alone think about rate hikes.

As was mentioned in yesterday’s Bernanke press conference, the current consensus for a Fed funds rate hike is sometime in 2015. That, of course, assumes there will be a pickup in economic activity beyond what we are currently experiencing, a falling unemployment rate from today’s level, and inflation slightly higher than today’s level. Until proven otherwise, I find it safer to assume we will not see enough of an organic pickup in growth so as to induce the Fed to hike rates in 2015. We are still living in a business world dominated by a cost-cutting mentality that won’t favor real wage growth. And we are living in a world of rapid technological advancements, skills mismatches, and unfavorable supply/demand dynamics in many markets that do not favor inflationary conditions occurring absent unrelenting liquidity from the Fed. That is a world in which any moderate rise in rates from today’s levels is a buying opportunity for fixed income investors.

I think the Fed knows all this and the voting members on the FOMC are terrified to show the world just how much the Fed’s policies have done nothing but distort financial asset prices. I certainly don’t envy their position and wish them nothing but the best in getting out of the difficult situation in which they find themselves.

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