EC A Visit From The Doom Squad

Nobody got rich. Don't expect those Lamborghinis you see on Instagram to stay parked in their driveways forever.

We are here for a few reasons.

  • People had fewer expenses during the pandemic, paid down debt, and saved money. Plus, they got stimulus checks.
  • Also, the Fed rescued the markets with emergency liquidity facilities but never turned off the liquidity.

All of this caused risk assets to reach absurd levels.

There is a school of thought that the Fed has recognized its error and may begin tapering in Q4. That should be interesting, to say the least.

Everyone knows this. What they don’t know is what happens next.

Monetary Policy

I suspect that the downturn will come from the Fed tightening prematurely, relative to expectations. I have heard that the Fed is not really aware of its role in creating the bubble, but it’s kind of hard to ignore the accumulation of evidence after a while.

The Fed has two mandates: price stability and full employment. Right now, it is paying much more attention to the latter. But 20 years ago, we speculated whether the Fed should have a third mandate—to prick an asset bubble to prevent it from getting any bigger.

Alan Greenspan had some thoughts on it at the time. He said that it is difficult to know that you are in a bubble—you only know with the benefit of hindsight. But I think you would have to be pretty obtuse to not see the signs that are everywhere.

In terms of tapering, there are a lot of different ways the Fed can do it. It can:

  • Cut back or eliminate its lending facilities.
  • Eliminate purchases of corporate bond ETFs or cut back on purchases of corporate bonds in the secondary market.
  • Taper purchases of mortgage-backed securities or even Treasuries.

The Fed has to manage the communication on this very carefully. Otherwise, it has the potential to crash the market. That's because the market is entirely dependent on Fed stimulus at this point.

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Disclaimer: The Mauldin Economics website, Yield Shark, Thoughts from the Frontline, Patrick Cox’s Tech Digest, Outside the Box, Over My Shoulder, World Money Analyst, Street Freak, Just One ...

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William K. 1 month ago Member's comment

Unfortunately it is not obvious that "But this is a market phenomenon, not an economic phenomenon. If we learned anything from 2020, the stock market is not the economy." To quote the author. And so while certainly some action is needed on the part of the fed I have no illusion that the correct action will be picked, or that it will be understood that the stock market really IS NOT the economy.