Monday, August 12, 2013

What to Watch For; I Think

The FED Bank in San Francisco issued an interesting report, first reported on Zero Hedge, which states:

Conclusion: Asset purchase programs like QE2 appear to have, at best, moderate effects on economic growth and inflation. Research suggests that the key reason these effects are limited is that bond market segmentation is small. Moreover, the magnitude of LSAP effects depends greatly on expectations for interest rate policy, but those effects are weaker and more uncertain than conventional interest rate policy. This suggests that communication about the beginning of federal funds rate increases will have stronger effects than guidance about the end of asset purchases.

This is kind of like saying; you can pour on as much gasoline as you want to but just beware of lighting the match.

Namely QE has little effect but once the FED says they are increasing the Funds Rate all hell will break out. As it is the collapse of the bond market is the canary in the coal mine, the market is already anticipating this. The key question will be:

1. If the FED readjusts the FED rates will they be adjusted towards inflation, or pushed ahead of inflation?

2. Will the push to higher rates drive market perceptions and result in higher equities?

3. Will this result in inflation?

I am reminded of the Rowe conjecture, that balance between reality and perception. I suspect we may very well be in for a rocky ride.