Is the Fed done easing?

That is the question many investors would like answered. How one answers this question has important implications regarding the arrangement of a portfolio. If you believe the Fed will continue, then financial assets may hold their current range. If you believe the Fed will step aside, then financial assets are likely to drop, perhaps plummet. 

Graham Summers provides his opinion:

This confirms what I’ve been saying for months: the Fed has realized that the consequences of QE (higher cost of living) outweigh the benefits. This is why the Fed only decided to extend its Operation Twist program during its June FOMC: the political climate in the US will not tolerate a large-scale move by the Fed unless a major bank collapses or some kind of systemic risk hits.

This means… that the primary prop underneath the US stock market and financial system (namely Fed intervention) is slowly being removed. What follows will not be pretty and smart investors should be taking steps now to prepare in advance.

Mr. Summers is insightful, but on this particular issue I respectfully differ. Mr. Summers’ points contain the reasons why I believe the Fed will take more action. He expects that we are already, or shortly will be, in another recession. For obvious political reasons, he does not believe that government will declare that fact until after the November election because it would highlight a number of embarrassing conditions:

  • The first time in the post-war period that the US has entered a recession in which industrial production failed to exceed its previous peak
  • The first time the US entered a recession when average unemployment duration was already at record highs
  • [T]he civilian employment-population ratio is at levels not seen since the ’70-’80 (meaning that fewer and fewer Americans are in the workforce)
  • [A] recession in which food stamp usage is already near record highs
The willingness to ignore reality and not declare another recession (when many feel the first one didn’t end and several indicators have worsened during the “recovery”) indicates a political class that will do anything necessary to survive. Not declaring a recession does not mean immunity from its effects.
A decline in financial assets would likely be more devastating than some egghead economist declaring a new recession.
The political considerations to which Mr. Summers points are the same forces that ensure more Fed easing, whether announced or surreptitious. Easing will not solve economic problems but it may hold financial assets up until after the election. Inflation is unlikely to become obvious before that.
After the election, the immediate political pressures are off, but then continued government funding becomes an issue. It is unlikely government can fund its profligate spending without the Fed continuing its assistance. In 2011, the Fed purchased 61% of treasury issues. Does anyone believe the government would not send out social security or welfare checks without exhausting every possible alternative to avoid this situation?
The Fed likely has a hard, but perhaps not long, road ahead. Expect it to continue to be the great Political Enabler that it always has been until market forces in the form of inflation destroy this form of political plunder.