CITI: Here's Why The Fed Wants To Slow Down QE, Even Before The Economy Hits Its Goals

leaky faucet

Unemployment is well above the Fed’s economic target, and inflation is low and falling.

So why is there even talk of the Fed slowing down QE (popularly called tapering)?

Citi’s foreign exchange expert Steven Englander explains the real motivation: a desire to curb speculation.

Englander explains that in addition to economic improvement, this is the Fed’s big worry.

I would add concern that balance sheet expansion is generating returns driven by pure risk, rather than top line gains. The evidence: strong outperformance of dividend versus growth and NASDAQ stocks in the first four months of 2013, the bidding up of low quality EM debt markets, the boom in non-investment grade debt and the exponential improvement even in the worst hit US equity markets.    

Putting together Bernanke testimony and WSJ, FT and Market News stories, we have a Fed that sees tapering as a priority even in an economy that creates less than 200k jobs per month. However, it still seems intent on using communications strategy to talk rates down even while pulling liquidity – hence the emphasis on possible two-way QE moves and ultra-low rates for an extended period. The Fed may be trying to promise low long-term rates for an extended period so that the it keeps the perceived benefits of low rates for activity while  unwinding froth. The implied commitment to investors is that the heat in the lobster pot will be turned up so slowly they will not even notice that they are being cooked.

For more on tomorrow’s big Fed announcement, see a preview here.

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