Between the Lines
by Gary D. Halbert

To the surprise of many, the Fed Open Market Committee (FOMC) voted yesterday to continue its $85 billion a month in purchases of US Treasury bonds and mortgage-backed securities indefinitely. So no taper. Stocks soared on the news and the Dow and S&P 500 indexes surged to new record highs. Gold spiked higher as well.

The Fed’s policy statement released yesterday at 2:00 PM EST spoke about continued moderate economic growth and the modest improvement in the unemployment rate recently. However, the Committee is apparently concerned about the recent rise in longer-term interest rates and wants to wait and see what impact that will have on the economy and the labor market before reducing its monthly QE purchases.

“Taking into account the extent of federal fiscal retrenchment [the sequester], the Committee sees the improvement in economic activity and labor market conditions since it began its asset purchase program a year ago as consistent with growing underlying strength in the broader economy. However, the Committee decided to await more evidence that progress will be sustained before adjusting the pace of its [QE] purchases. Accordingly, the Committee decided to continue purchasing additional agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month.”

To no one’s surprise, the Fed voted to continue keeping the Fed Funds rate near zero for an extended time, presumably at least through 2014, or until the unemployment rate dips below 6.5%.

As has been the case all year, all but one of the FOMC members voted in favor of the policy outlined above. Only Kansas City Fed president Esther George voted against the policy, as she has all year. Given that no other FOMC member has voted against the huge QE purchases this year explains why there was little interest in tapering at the latest meeting.

In his press conference following the meeting, Fed Chairman Ben Bernanke defended the latest decision to continue asset purchases. Without using the word “taper,” the chairman said that the Fed might move to reduce monthly purchases before the end of this year. There are two more FOMC meetings this year, October 29-30 and December 17-18.

Some Fed watchers suggested that Mr. Bernanke may already be deferring to Vice Chair Janet Yellen who is likely to be the next Fed Chair (especially since Larry Summers bowed out). Ms. Yellen is considerably more “dovish” than Bernanke, and most believe she favors continuing QE beyond this year, unfortunately.

At the end of the day, here’s the main question: Why did Bernanke make such a big deal in late May and June about tapering its QE purchases, only now to suggest it doesn’t particularly matter? At the press conference, Bernanke was asked this question in various ways, and was reminded that two-thirds of economists polled by The Wall Street Journal expected the Fed to taper at this meeting. Yet Bernanke’s response was: “I don’t recall stating that we would do any particular thing at this meeting.”

It is clear to me that Big Ben rather enjoyed this monetary head-fake, especially with his flippant answer just above. Of course he never says in advance that the FOMC will do any specific thing at its upcoming meetings. That was an intended insult! And he went on to say: “We can’t let market expectations dictate our policy actions.” Put differently, the media can’t tell us what to do.

Now that the question of Fed QE purchases is out of the way for a while, I expect the markets to begin to be more sensitive to the upcoming federal budget battle and the debt ceiling stand-off. President Obama vowed once again this week that he will not negotiate with Congress on the debt limit. I think he means it. If so, a government shutdown later this year is not out of the question.

The Dow fell almost 2,000 points when we last had a budget/debt ceiling battle in 2011. It may be that the “no taper” news from the Fed yesterday is a prelude to a major market top just ahead.  Sooner or later this unprecedented debt binge is going to catch up with us, and it won’t be pretty!