Will the Fed Crimp the Feeding Tube?June 13, 2013 Posted by: Joe Morgan, CFA
The views expressed in this column are solely those of the author and do not reflect the views of SVB Financial Group, or Silicon Valley Bank, or any of its affiliates.
In 2005, Cornell professor of Applied Economics provided bowls of soup to (likely) starving students and found they ate 73 percent more soup when made "bottomless" by refilling from a hidden tube in the bottom of the bowl. In addition, the two groups of soup-eaters rated themselves equally full.
Investors it seems are not far from starving student status as their thirst for more and more QE demonstrates. Consistent gains in the stock market have at least partially been driven by ever more quantities of bond purchases by the Fed (QE). Recently, however, many Fed officials have been making noise about reigning in or "tapering" such purchases. What happens then?
When the Fed begins to squeeze the feeding tube of the markets, investors will discount a series of future tapers and perhaps even rate increases. The perceived support provided from QE in the past will turn into a headwind going forward. It is the Fed's job - though they adamantly say they do not
target stock prices - to gauge how far to crimp the tube to hold back inflation while still allowing the economy (and markets!) to grow.
This is nothing new.
What is new is how much their margin for error has been reduced. As the Fed continued to inject cash into the economy, expectations for continued injections grew both in terms of quantity and certainty. As the quantity of injections declines followed by the certainty that loose money will always be
the Fed's policy, markets will have to contend with a new Fed - one that is more focused on fighting inflation.
We haven't seen that for eight years - by far the longest period of loose money in the modern Fed period.
Source: Bloomberg, SVB Asset Management Read More