Fed’s Wavering Mood

Bernanke’s bold announcement back in spring triggered an acute sell-off, prompting a ramping upsurge in interest rates. Global capital flows reversed, confronting many emerging economies with the dire prospect of currency crisis and a sudden investment slump. Fearing such a brisk departure from the current cheap money stance may act as a brake to the slow motion recovery in the US, added further matter for concern.

Bending to such devastating side-effects, the Fed seems plunged in a wavering mood towards tapering. While fully conscious of the danger embedded in a program that so openly curtails its room of manoeuvre for managing monetary policy, it is stuck in an uncompromising wait and see stalemate.

Prolonging such self-defeating tactics seem out of reach, the Fed being bound today to break the current deadlock. It may perform a one-off cut in the bond buying scheme, avoiding any precise commitment as to the rhythm and timetable of its phasing out. If only for the sake of not tying up the future Chairman’s hands. Most observers predict a rather moderate reduction, around $10 billion, aimed at reassuring the markets.

All the fuss about tapering has precluded a deeper debate on monetary issues. Yet, sooner or later, a clear guideline must be set in conducting this policy. It won’t be easy as markets flatly ignore the need to switch away from the current benign neglect. The huge size of the ongoing securities purchase doesn’t stand as the real problem. The Fed is able to reverse the trend, should inflationary bouts emerge, as this comfortably cushioned war chest can be disposed of without resorting to increase reference rates.

The really back-breaking effect triggered by QE is the message it conveys to the markets on a long term bet on cheap money. Such loose environment fuels a massive credit expansion far beyond the amounts pumped in by the central bank. Taking risk seriously stands as the next casualty, downgrading solvency to a mere gamble.

In these circumstances, any monetary stiffening might put to severe test many reckless investment decisions taken during the bonanza frenzy. In many ways the loose standards applied now do not appear so different from bad practices that led to disaster back in 2008. Today’ drive for risk appetite is close to the careless conduct so much criticised in the aftermath of the financial implosion.

For all the measures implemented to redress financial solvency, the mushrooming of shadow banking and increased indebtedness represent now a real danger. The more so as emerging countries could face a similar crisis as the one experienced by Asian economies back in the 90s. The Fed has no alternative other than following a prudent and gradual path in reining in the cumulated distortions. Any false move might turn the global economy back to step one.