EL-ERIAN: The Fed (Bernanke) Better Be Right About The Economy

Virtually every segment of the fixed income, equity and commodity markets sold off viciously this afternoon on the back of the Fed statement and Chairman Ben Bernanke’s subsequent remarks. In the process, liquidity evaporated in certain places causing even more disorderly price moves.

The immediate trigger for this afternoon’s market debacle was heightened concern that the Fed intends to reduce its support of the economy, undermining the markets’ notion of the “central bank put.” And in reacting to signs that the Fed may gradually take its foot off the accelerator, markets completely brushed off repeated efforts by Chairman Bernanke to link ever more precisely the process of tapering to specific progress on the unemployment and inflation fronts.

Given that this afternoon’s market reaction was basically a repeat of what occurred a few weeks ago in response to initial talk on Fed tapering, many will assume that the Fed took a calculated risk in refusing to walk back from earlier such talk.

Such a Fed approach would makes sense if officials are highly confident of two factors and wish to act on a third consideration: •that growth and jobs dynamics are firmly improving, and will do even better in the future; •that inflation and inflationary expectations will converge upward towards the 2% target, and do so in a gradual fashion; and •that it is now time to try to take some air out of the excessive risk taking balloon, and that this can be done in an orderly fashion.

Markets will now adjust to a new negative shock to the trio of the liquidity, risk and term premia. Heightened volatility will also fuel even greater risk aversion, including lower

QE was never really about the economy. QE was and is about the big banks. Which means it is now about propping up the world’s worst ever bond bubble. That bubble has become scary in recent weeks with interest rate increases and falling bond values. Falling bond values will expose the insolvent banks.

Bernanke and friends will continue QE while pretending that they’ll significantly pull back.

The Fed lies; they will keep printing incredible amounts of money while faking otherwise. Watch what they do; not so much what they say.

Savers, depositors, pensioners will continue to get screwed by dollar depreciation over time.

One should look past day to day noise and see the longer term picture.

Central bankers in their attempt to prevent a deflationary depression have printed money and distorted the price of all assets (stocks, bonds and real estate). Stocks have been going up because it is the only game in town with low rate interest (ala cheap money). Prices have gone up anticipating economic recovery down the road. Economic recovery is at best tepid and price of stocks are too high. Fed Reserve is in a pickle, print too much and you may trigger problems associated with devalued currency, pull back on the printing and buy backs and stock market crashes and triggers a financial panic (too many institutions and persons built their recovered wealth on an Fed inflated stock market). IMHO if you made money in the stock market, get out. Big players will reposition themselves, and small investors do not want to be caught in the middle of shifting forces. Even if the Fed attempts a delicate pull back, overseas events can unhinge the whole system. Greece is out of money again, Spanish debt is approaching GDP, and Italy is slipping rapidly into a deep depression as small business are closing in record numbers. Rumor also has it that the Fed Reserve has been secretly sending US printed dollars to keep the EU banks from running out of money. Add to that US banks have currency/bond swaps with EU banks that are traded in secret off shore exchanges. God knows what the interlocking connections we have with EU banks and Japan. Any implosion overseas can cascade into our financial system within 72 hours.

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