Fed exit strategy: the mother of all head fakes

by Goldmoney

“Exit strategy” is the current buzz phrase among market watchers, with the dollar rallying in recent days and weeks on expectations that all is well with the US economy again, and that the Fed can now start thinking about ways of selling assets and “exiting” from its current commitment to perpetual quantitative easing.
Given this growing narrative and the fact that US stocks continue to race higher, gold and silver remain under pressure – with a “sell the rallies” mentality continuing to predominate trading in these metals. This could change though, depending on what Fed chairman Bernanke says in congressional testimony later today (if he sounds more dovish on monetary policy and pessimistic about the economy than expected, this should support the metals; in the opposite case, the metals could go lower).
From a longer-term perspective, it really doesn’t matter what Bernanke says. Talk from Fed officials about “exit strategies” is nothing more than a head fake: a way of convincing the markets that central banks are still in control, and that there’s nothing to worry about. The central planners have it all under control.

But the combination of the lengthened maturity profile of the Fed’s assets, the current paltry yields on bonds, and the fact that the Fed would presumably be selling into an environment where inflation is rising (along with yields) presents challenges. Not to mention the fact that this is as much a flow problem (the Treasury will still be running deficits as far as the eye can see) as it is a stock problem. This point should be emphasised by the fact Washington is in the process of casting aside what few legislative checks remain on its ability to borrow and go deeper into debt ad infinitum.
Even assuming that the Fed has the ability to surmount these challenges – a somewhat heroic assumption – is there any guarantee they can get the timing and execution right? The fact that the Fed left rates too low for too long in the run up to the 2007-08 crisis doesn’t inspire confidence on this front. And given the political pressure the Fed will continue to face to accommodate large government deficits (that flow problem again), it seems especially doubtful that the FOMC will prove too eager to attempt any form of early exit.
Hope for the best, but prepare for the worst.