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Positive data makes Fed decision easier

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From earlier statements this year, Fed chairman Ben Bernanke's attempts at discontinuing the third round of quantitative easing was met by the markets with fear and trepidation. Many times over the summer, markets would plummet a day after any mention of ending the Fed's stimulus program. Known as QE3, this was the third injection of stimulus conducted by the Fed since the economic collapse in 08'. QE3, which started a year ago, is the 85 billion dollar injection the U.S. economy has been receiving in the form of bond purchases every month. This was done in an effort to stimulate the sluggish job market, and see that the economy didn't slip into another recession. Originally the Fed chairman targeted getting the unemployment rate down to 6.5% before pulling the plug on this latest round of easing.

In an effort to avoid a market meltdown, Bernanke treaded lightly in future statements, using the softer word 'tapering'. However with market data showing signs of improvement, perhaps now he felt was the right time to act. Last weeks jobs report showed that the original projection of 183,000 was met with a better than expected number of 203,000. That information was bookended by this Friday's report that the GDP had gained 4.1% in the last quarter.

The markets reacted positively after the announcement from the Fed chairman, gaining 285 points on Wednesday, 11 points on Thursday and Friday finished with a solid 42 point day. The Dow finished the week at 16,221.14, the highest it has ever been, and far and away higher than anyone would have predicted back in 2009 when it bottomed out at 6,600 points.

The move, however, wasn't exactly as bold as it may sound. Think less Clint Eastwood, gunslinger taking life or death chances, and more Bill Murray in 'What about Bob'. Bernanke may have found inspiration from Murray's psychiatrist, Leo Marvin played by Richard Dreyfuss. Richard Dreyfuss plays his smug psychiatrist who shamelessly promotes his rather trite book 'Baby Steps'.

"It means setting small reasonable goals for yourself one day at a time, one tiny step at a time."

Bernanke announced that his 'baby steps' would be to cut 10 billion from the monthly figure, reducing it to a mere 75 billion. The good news was also aided by the announcement that the Fed will continue to keep interest rates at all time lows, even after the bond buying experiment is completely finished. Interest rates have remained at their lowest they've ever been since the collapse in 08'. This was done in an effort to encourage lending after it became apparent that most of the banks were running on toxic assets.Without the TARP (QE1), a case could have been made that the credit supply would grind to a halt, sending the world's economy into a deep freeze.

Although this weeks, move was seen as a positive reaction to upbeat market data, the move may also have been an effort to curb another emerging problem. That is one of inflation, or a lack thereof, news that inflation had fallen well behind its Fed chartered 2% comfort mark. The Fed controls the rise and fall of inflation by setting the interest rates. Interest rates that are set too low encourage banks to over borrow and consequently over lend to consumers, which results in too much money in the system. If the economy is humming along too fast, the Fed will raise the rates, thus slowing the economy to avoid an inflationary spike. This time however is different, which may be indicative of how out of sorts the economy really is. Here the economy has absorbed three major rounds of bond purchasing with interest rates at anemic levels. Traditional logic would dictate that this scenario should result in a saturation of money, sending inflation rates up. Instead, over the last couple of months prices for certain goods and services have gone down.

Many critics of the Fed bond purchases, (aka printing money) argue that it will lead to an artificial saturation of dollars in the market. On paper, this should result in destroying the currency's value. In the current situation the opposite is occurring. Although no one can predict future outcomes, there is something counter intuitive for an economy to: (1) be growing its GDP; (2) lowering unemployment rate. Yet concurrently, a lack of consumer spending is sending inflation on a downward trend.

One reason for this discontinuity may be a misinterpretation of data, as a result of some data lags behind tangible 'realtime' economic output. Contrary to oversimplification by economists on cable news shows, the economy is a massive organism that does not behave in an: if A then B linear logic.

Nevertheless that does not stop economists from trying to crack the code. One of the more conventional means for gauging the strength of the dollar, is to look at how commodities are faring. In the case of the dollar, the price of gold is traditionally the way to pick up on currency trends. If the value of an ounce of gold goes down, that is a sign that deflation is occurring and the dollar is actually gaining strength. The value of gold began to rise in 06' when the massive housing bubble began to show signs of bursting. Then the value was somewhere around $550 per ounce, since then the price shot up to over $1800 per ounce, however since its peak in 2011, it has declined 33% to the $1200 mark.



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