Ben Bernanke gave a press conference after the last Fed decision where he laid out the Fed`s plans for exiting their stimulus program and the market to put it bluntly freaked out with Bonds yields soaring, and all other asset classes selling off sharply. The Fed didn't like the reaction, especially with bond yields jumping much higher than they ever anticipated, and immediately sent numerous Fed governors to the media trying to talk back the market, again especially bond yields.
Ben Bernanke Finds Himself Stuck in QE Conundrum
The Definition of a Bubble
The fact that the market would react so dynamically without the fed actually doing anything, and only talked about slowly transitioning from QE purchases in a tapering fashion with a rather drawn out process through the summer of 2014 means the federal reserve has created massive bubbles in several asset classes.
Further Reading: Gasoline Futures Market Rises 45 Cents in 10 Days
This is the very thing they were lecturing everyone about on how Ben Bernanke policy going forward would be different this time and that they finally learned their lesson after the 2007-08 financial crisis caused by having the fed rates too low for a prolonged period in order to stimulate the housing industry.
Well not only has the federal reserve kept the fed funds rate too low for far too long a period, but they injected billions and billions of dollars into asset classes with their various outright purchase programs which had the effect of pushing many asset classes several standard deviations beyond their normal sustainable levels through normal market conditions. This is the definition of a bubble all over again!
Further Reading: China GDP To Hit 6.7%
The catch 22 is that they cannot exit now without markets and asset classes freefalling back to natural sustainable levels, yet markets are at hundred year highs! The real problem is that if they cannot exit now, then they push markets and asset classes even higher artificially to even more unsustainable levels! The drop becomes even more pronounced a la the Tech bubble where stocks trading in the 100`s dropped to zero, silicon valley had their fire sale for property as all the business built up around unsustainable market valuations came crashing back to reality.
The thought was that, or rather the original hope by the fed, I am sure they thought of it more as a theory was that they would push or support asset prices up until the economy picked up and then the next business cycle would kick in and take over or be able to support asset prices as they withdrew the stimulus. But it has been five years of artificial stimulus and the economy still cannot hold up or replace the fed`s stimulus measures without asset classes falling precipitously.
Further Reading: Oil Myths & Why WTI Is a Short
The Bubble is too Big for Original Ben Bernanke Plan
Here is the most salient point the bubble is so big now after five years of artificial stimulus that even a robust economy that creates 350,000 new jobs each month, and a GDP of 3.5% cannot replace the offset of the fed removing their stimulus from the markets. Asset prices are going to fall rather hard once the fed leaves as we witness even at the hint of tapering.
This is because asset prices have been inflated for five consecutive years. This has never been done in the history of financial markets. Ben Bernanke has outdone every previous bubble they have ever created, and as all asset classes are inter-related, leverage is used, and the correlation of asset classes in greater than ever before in markets. There is no possible exit without causing massive money flow disruptions in financial markets. Every asset class is based upon and relies on the fed stimulus each month like a financial market crack addict.
Ben Bernanke and The Withdrawal Effect
Shoot you cannot even get prescription sleeping aids these days without your doctor lecturing you on the effects of the withdrawal phase. Not receiving $85 Billion each month that finds its way into financial assets is going to create a significant withdrawal phase for markets. The longer the policy continues the more severe the withdrawal phase becomes similar to withdrawal from a highly addictive drug.
Portfolio Expiration is a nice trick, but only addresses a third of the Withdrawal Effect
The talk of just letting the portfolio expire on the fed`s books without them selling these assets into the markets completely misses the point. Yes that will make it worse selling those massive positions, but that is a foregone conclusion that they cannot sell those into the market. It is the stimulus each month during these QE1,2,3,4 programs that being taken away is where there is no way to mitigate or hedge the market withdrawal, i.e., the bubble effect.
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