Fed Puts Ceiling on Long-Term Rates
The President of the Europe's central bank said back in July of 2012 that it would fight rising borrowing costs by doing "whatever it takes" to ensure sovereign bond yields do not spiral out of control. This past week Mr. Bernanke took a page from Mario Draghi's playbook and tacitly indicated that the Fed will now also promise to keep long-term interest rates from rising by any means necessary.
Starting from its inception, the Fed influenced the economy by adjusting the interbank overnight lending rate and providing temporary liquidity for financial institutions. However, in the modern era of central banking (post 1971) the Fed has resorted to unprecedented and dangerous manipulations, which are increasing by the day.
The Fed began in November of 2008 to purchase longer-dated assets from banks. Bernanke's plan was to greatly expand the amount of banking reserves, put downward pressure on long-term interest rates and to boost the value of stocks and real estate assets. He has since succeeded mightily in accomplishing all three. But since viable and sustainable economic growth cannot be engendered from artificially manipulating interest rates and boosting money supply, GDP growth and job creation have been anemic at best.
Therefore, the Fed has resorted to trying yet another unprecedented "solution" to fix the economy. Mr. Bernanke stated in his press conference following this week's FOMC meeting that the level of asset purchases would remain at $85 billion per month because," the rapid tightening in financial conditions in recent months could have the effect of slowing growth..." The only possible meaning Bernanke could have in mind when saying "the rapid tightening in financial conditions" is the increase of interest rates. The shocking part is that the rise from 1.5% to 2.9% on the Ten-Year Note does not even bring borrowing costs to half of the average level going back to the time when Nixon completely unpegged the dollar to gold.
What the Fed has done is historic in nature and yet it has received nearly zero attention in the main stream media. Bernanke has essentially admitted that just the threat of reducing QE--let alone actually bringing it down--was enough to send interest rates rising to the point in which economic growth is severely hampered. In other words, the Fed was forced to acknowledge that tapering is tightening and is now obligated to expand the balance sheet without end or be willing to allow a deflationary depression to reconcile the imbalances of its own creation.
This is because the price of risk assets and level of aggregate debt are so far above historic measures that even the slightest increase in borrowing costs renders the economy insolvent.
Investors would be wise to ignore the Fed's rhetoric about ending QE and concentrate only on what it actually does. Hard assets offer the best protection against a central bank that is incapable of extricating itself from monetary manipulations.