The One Goal of the US Federal Reserve…Low Interest Rates


India, which has seen a collapse in the rupee, wanted tough language stressing the need for the US in particular to take heed of the havoc that could be caused by speedy or unexpected tapering of the QE programme.‘ – Financial Times

It’s a funny old game. Emerging market economies complained when the US Federal Reserve embarked on its various money printing programs.

Now the emerging market economies are complaining as the US hints it will end its various money printing programs.

The poor old Federal Reserve just can’t please anyone can it?

Well, here’s some good news (or is it bad news?) for the emerging market economies. While the Federal Reserve may slow down its bond buying program, we can tell you now that the Fed has absolutely no intention to stop stimulating the US economy.

To us that means one thing: higher asset prices…

If you’ve read – as we have – the transcript of US Fed chairman, Dr Ben S Bernanke’s press conference on 19 June this year you’d know Dr Bernanke and his buddies have only one thing on their mind – low interest rates.

You may have seen a lot of talk in the mainstream press about the Fed’s plans to taper its asset purchases.

You may also have read commentary that says the Fed will stop stimulating the economy when the unemployment rate reaches 6.5% or 7%. That’s got the markets nervous.

We can only conclude that those mainstream commentators haven’t read the transcript of that press conference. Here’s why…

The US Federal Reserve Has One Goal

Among others, here’s one of the key comments from Dr Bernanke that gives the game away – not that he’s trying to hide anything. We’re not used to defending Dr Bernanke, but it seems plain to us that he’s upfront with the markets on his intentions.

Here’s what he said:

…holding all of those securities off of the market and reinvesting and still keeping [and] rolling-over the maturing securities, will still continue to put downward pressure on interest rates. And so, between our commitments to a low federal funds rate and the large portfolio, we will still producing a very large amount of stimulus – in our view, enough to bring the economy smoothly towards full employment without incurring unnecessary costs or risks.

It must be nice to live in the academic world where economic meddling results in no adverse side effects – because the spreadsheets and models don’t allow for it.

But that’s by the by. The other key point in the quote from Dr Bernanke is the reference to ‘full employment‘. Most mainstream economists believe that ‘full employment’ is a 5% unemployment rate.

That’s mainstream economists for you.

The fact is as long as the US Fed believes their policies aren’t harming the economy they’ll keep interest rates low, keep buying bonds, or try some other hare-brained scheme.

And that’s the thing. The Fed’s goal is low interest rates. Whether that means the Fed buying government bonds or doing something else isn’t important. If the tapering of bond buying results in rising interest rates the Fed will stop tapering or do something else to keep rates low.

Not that we agree with those policies, we’re simply saying that’s what will happen.

But what about when Dr Bernanke leaves the Federal Reserve next January? Oh, don’t worry about that either. As Bloomberg News reports:

A Federal Reserve headed by Lawrence Summers may give financial markets even stronger support in times of stress than it did under Ben S. Bernanke.

Bloomberg quotes David Zervos, managing director at Jefferies LLC. Zervos says:

Larry is no fool and for someone who loves the art of the bailout, this is by far the best seat in the house. The chair of the Federal Reserve offers unprecedented monetary and fiscal policy-making opportunities – especially in a time of crisis.

Oh boy, Helicopter Ben will have met his match. If the world’s markets want a man who’s not afraid to shower the world with money and other central bank stimulus, Larry Summers is the man.

Stocks to Rally Even if the Recovery Never Comes

Do you see what we mean when for the past year we’ve forecast that markets will continue to rally for the foreseeable future?

That doesn’t mean markets won’t crash sooner or later. And it doesn’t mean you should ignore warnings about a potentially massive stock market collapse.

But it tells you that despite all the talk about tapering, the US Fed still believes it has plenty of work to do to keep rates low.

So, why do most people think the Fed will soon remove stimulus? Our bet is they aren’t reading between the lines. The Fed can’t just come out and say it will stimulate the economy forever.

That would imply the US economy will never recover. And if the Fed said that investors would correctly draw the conclusion that the Fed’s plans had failed. Even the promise of stimulus wouldn’t be enough for investors to buy stocks.

The Fed has to keep promising that the recovery is near. But when you ask them how near it’s always about a year away. It’s like the old saying about tomorrow – ‘tomorrow never comes’.

The Fed hopes investors don’t figure this out. As long as investors believe the folks at the Fed know what they’re doing, investors will play along.

After all, they’ll think, if that recovery really is within touching distance, the last thing they’ll want to do is sell stocks, just before the market takes off. And in our view, stocks are about to begin the rally that will take the main Aussie index to 7,000 points in 2015.

It’s that optimism, leading the market on, promising that recovery is just around the corner that has gotten the market to where it is today. Sure, investors may wise up to it and stocks could fall – and soon.

But we’re not betting on that just yet. We agree with those who say stocks are heading for a big crash. We agree 100%. But it won’t be before the Aussie market climbs another 36% from here.

Cheers,
Kris+

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Money Morning is Australia’s most outspoken financial news service. Your Money Morning editorial team are not afraid to tell it like it is. From calling out politicians to taking on the housing industry, our aim is to cut through the hype and BS to help you make sense of the stories that make a difference to your wealth. Whether you agree with us or not, you’ll find our common-sense, thought provoking arguments well worth a read.

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