Since the recent stock market sell off, Federal Reserve members have been coming out in droves in effort to reassure stock market participants that quantitative easing would not end. In fact, voting FOMC member Bill Dudley said that QE-3 could actually increase if the labor market doesn’t improve. He also went on to say that a rise in short term rates is a long way off. There are two other members of the Federal Reserve that are scheduled to speak today. We can only suspect that the central bank is doing everything it can to keep the fear out of the stock market before the important Independence Day holiday next week. After all, consumer spending accounts for roughly 70.0 percent of the U.S. gross domestic product (GDP) in the United States. The central bank would not want to disrupt consumer spending during a busy period in the United States.
Is the Federal Reserve sending a message of confidence to the markets? After all, the fed funds rate (overnight lending rate to the large banks) is at zero to a quarter percent. So basically, the large banks can borrow free money. The fed funds rate has been this low since December 2008, which is really an unprecedented amount of time. The central bank is also currently buying $85 billion a month worth of U.S. Treasuries and mortgage backed securities. It has been reported that the Federal Reserve’s balance sheet is now over $3.1 trillion. The Federal Reserve claims that there is very little inflation in the United States, so there are no problems with the easy money policies they are implementing. If people are wondering why there is little inflation in the United States, its because it is being held on the central bank’s balance sheet. Many other countries such as Brazil, India, Russia, among many other nations are feeling inflation.
Will the market moving institutions begin to lose faith in the central banks in the United States and around the world? The Bank of Japan (BOJ), Bank of England, the European Central Bank, and many other central banks are all implementing easy money policies. The S&P 500 Index is just off of its all time high, yet economies are nowhere close to operating at full strength. Just a few days ago it was reported that the gross domestic product in the U.S. grew at just a 1.8 percent annualized pace in the first quarter. This is not a very good number and well below expectations of 2.4 percent. Most economists do not expect this number to get much stronger any time soon. So it is safe to say that the major stock indexes are actually moving higher because of the easy money policies by the Federal Reserve.
It is safe to say that the Federal Reserve seems to be flip flopping on their words. Last week, Ben Bernanke said he would start to taper QE-3 later this year and end it in mid-2014, today Bill Dudley said that the central bank could actually prolong QE-3 if the labor market does not improve. What is the true story here? Eventually investors could lose faith in the central bank. They obviously believe that as long as the stock market trades higher the economy will improve. Will this lead to the mother of all bubbles in the future? After all, their past track record suggests that another bubble is in the cards again.