The Federal Reserve spoke yesterday, and not surprisingly decided to buy more treasury bonds to keep expanding the balance sheet. It might have been a bit surprising that they have now also explicitly targeted an improvement in the unemployment rate (6.5%) and stated a tolerable inflation band (2.5%) for investors to use as guides for when the Fed might engage in policy withdrawal. The market went up for a few hours, and then drifted back to earth and closed unchanged on the day; Fed decisions can’t force politicians to trade in political theatre and come up with a deal before the 11th hour.
So here we are digesting QE4, and we must ponder whether another leg of QE(Infinity) is good or bad news for asset markets? Our answer at the moment is simply that no-one can be sure what continuing these extraordinary policy measures will mean for markets.
The Bullish View
The Fed is clearly doing its best to fend off deflationary impulses in the global economy, and is likely trying to offset an approaching headwind of fiscal tightening next year. From a cyclical perspective this should be an on-the-margin positive, and one that could potentially produce asset bubbles that may develop from the bullish cocktail of excess liquidity. Asset bubbles can be a great thing for investors if they can be identified early and invested for the explosive part of the move. Of course, one needs to have the discipline to get out before the bubble bursts.
The Bearish View
Anyone watching the progression of QE programs can see the law of diminishing returns in the way asset markets are responding to each successive monetary intervention. Yes, more money is pumping, but organic demand continues to be tepid, and that has kept a lid on business investment and the velocity of money throughout our economy. In short, the skeptics believe that our monetary policy settings are like experimental medications for a patient who has no hope of healing through conventional medical treatments. The bears would say that these policies are likely to fail over the longer term, and are almost certain to contain many unintended consequences.
While we are in unchartered policy territory here, there are elements of truth in both the bullish and the bearish arguments. This lack of clarity about the short and long term effects of monetary policy is one reason why we don’t think investors should take an overly bullish or bearish allocation stance at this time.
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