Later this week, The FOMC is expected to introduce the concept of reducing the size of its LSAP program. Allegedly, this this the reason US Treasury yields are rising. The size adjustment is based on a foggy notion that the Cost of the program is beginning to outweigh the benefit. (cost = 0 so benefit < 0 ?) The C/B analysis of the policy is perceived to be overshadowing the Employment and/or Inflation metrics that the program was originally calibrated to.
The program’s efficacy has fallen somewhere between the 2 vocal and opposing views of it. The first is that the Fed cannot control rates beyond the shortest maturity and thus does nothing. The other is that the Fed is “manipulating and controlling” rates that would, if not for the FOMC, be at some other (higher ) level. Even a pedestrian glance of the facts dislodges both criticisms. Asset purchases can assist in unclogging financial system pipes and compress spread relationships- depending on the actual and expected success of that; the outright level of rates may decline.
We believe the present forecast and the shifting supply side of the equation (projected to drop by 40b/month) would allow for the program to be cut in half. The yield shift has been dramatic in speed and distance here at home, the pain has been felt elsewhere, however. EM countries (Brazil Indonesia, India) whose balance sheets swelled with foreign reserves during the Fed’s peak production have been decimated by the possibility of slowdown. Rising rates, capital flight, currency falls and hiking official rates to “stem the outflow” are a vicious cycle of pain far from the concept of “taper.”
We see the age of global central banking taking a “time out” if not ending. The hubris-amaggedon that was the financial system meltdown went global enough to utilize coordinated policies for a time. Central Banks are – at their core missions – domestic institutions. The adjustment to that reality has been – after an initial scare – the least damaging here. I ride with policy makers who “walk the walk” and fade those that “talk the talk.” I’m not convinced “walkin’ the talk” will be so clear cut.