In a much anticipated statement, the Federal Reserve on December 18 announced a change in monetary policy—that it will begin to taper its large scale asset purchase program.  The statement was coupled with additional guidance that interest rates will stay low for a considerable period.   The statement’s impact is more a tweak than a decisive policy shift.  This unconventional policy, initially begun in 2009 to spur forward the economy, has been ever-so-finely tuned.  Markets reacted positively.

This week we review three articles reflecting on the announcement.  The first, by Liz Ann Sonders, Chief Investment Strategist of Charles Schwab & Co., characterizes the shift with an analogy to easing up on the accelerator in highway driving.  The second article, by Pimco’s Mohamed El-Erian, urges continued caution based on the foundation the unconventional policy is built upon. The third article, by Justin Fox, author of Myth of the Rational Market, warns about the potential for financial market optimism morphing into exuberance and complacency.

Start Me Up:  Fed Announces a Much-Anticipated Taper.  Liz Ann Sonders of Charles Schwab explains that the Fed announcement can be characterized by an analogy from highway driving.  “New Fed policy is more like slowing a car’s cruising speed from 85 to 75 mph, and less like putting on the brake.  Positive market reaction may ease some of the consternation of Fed watchers that believe there is no way the Fed can engineer a benign exit from its unprecedented policy easing/unwinding….but history may be instructive…in the 1940s and 1950s, the Fed pursued very similar policies to deal with the debt that was incurred during the war.  Eventually, the Fed’s policies were successfully unwound.”

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Fed Wins Battle for the Exit—For Now.  Pimco’s Mohamed El-Erian urges caution in the wake of the equity market’s enthusiastic reaction to Federal Reserve policy change on December 18.  The Fed naturally hopes for an orderly exit from its large scale asset purchase program, first instituted in March, 2009 to spur the economy forward.  Caution is warranted because the Fed’s program to get the economy moving depends on “artificially-high asset prices to alter household and company economic behavior.”  Moreover, investors can be lulled into complacency, where equity prices overshoot fundamentals, with disruptive corrections the consequence.  (tiered registration required)

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 The Downside of the Fed’s Increasingly Complicated Expectations Game.  Justin Fox, author of Myth of the Rational Market, and frequent blogger for the Harvard Business Review, notes that “the market’s initial reaction to the beginning of the taper is great news, for now

[emphasis added].”  He cautions that “financial market optimism and confidence have a tendency to eventually morph into exuberance and complacency,” which in the 1990s was a precursor to market meltdown that is beyond the Fed’s power to control.

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J. Mark Nickell & Co.

Disclosure – The articles mentioned in This Week with J. Mark Nickell & Co. are for information and educational purposes only. They represent a sample of the numerous articles that the firm reads each week to stay current on financial and economic topics. The articles are linked to websites separate from the J. Mark Nickell & Co. website. The opinions expressed in these articles are the opinions of the author and not J. Mark Nickell & Co. This is not an offer to buy or sell any security.  J. Mark Nickell & Co. is under no obligation to update any of the information in these articles. We cannot attest to the accuracy of the data in the articles.