Wednesday, March 19, 2014

US monetary policy moving in the right direction

The Fed struck a somewhat more hawkish tone today - certainly enough to spook the markets. Expectations for the first rate hike have shifted forward by nearly a quarter, pointing to late spring of 2015 as the starting point.

This monetary stance, combined with another $10bn taper was the right move. Here are the reasons:

1. The $10bn cut per meeting removes much of the remaining uncertainty around taper trajectory. The reductions are on autopilot. Often it's not the policy itself but the uncertainty surrounding it that creates issues for the economy. That was one of the key problems with this open-ended QE - the fear of a painful exit put the economy on hold.

2. It is unclear if extremely low rates stimulate credit growth at all, and in fact some argue it could be the opposite. At the same time, savers, including many retirees, have been punished by negative short term real rates for years. This zero rate policy needs to end.

3. The US economy is stronger than is commonly believed. "How dare you say that, you heretic - don't you read all the financial blogs?" That has been the response from many. Perhaps. But it may behoove some folks to pay attention to the data ... More on this later. The point here is that the US economy will be fine without QE and with higher interest rates.

4. The current environment has created such hunger for yield that investors are increasingly taking higher risk in order to target the same performance they experienced in the past. Insurance firms, pensions, individuals - the behavior can be seen in a number of areas. The Fed's exit should help adjust some of the distortions.
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