What’s the Fed Going to Do?

Yesterday we worked through the illusion to the reality of the ECB’s “unlimited” bond purchases, the end result being that we discovered the ECB:

1)   Didn’t announce anything new

2)   Is implementing the same policies it’s tried twice before with no success (see Greece)

3)   Is implementing policies that neither Spain nor Italy will go for…

And finally…

4)   Has solved nothing due to the fact that of the two mega-bailout funds, one has only €65 billion in firepower left and the other has yet to be ratified by Germany

Today we turn our attention to the US’s Federal Reserve where the whole world expects the Fed to announce QE 3 at its FOMC meeting this Wednesday and Thursday.

There is a small problem of math with this. The Fed currently owns all but just $650 billion of the outstanding 10-30 year Treasuries. At this point, even a $200-300 billion QE program would create serious liquidity problems for the financial system. So scratch that idea off the list.

Of course, the Fed could potentially implement another agency/MBS QE program. But that would be a very political move with the Presidential election so close. This, combined with current food and energy prices, makes it unlikely the Fed would want to do this: too many consequences with too little to gain (stocks are at four year highs).

Indeed, if anything, the Fed is likely to pull a “ECB” move, namely promising something vague that it actually cannot deliver on. Why would the Fed do this? Because, like the ECB, the Fed is running out of bullets. Indeed,  St Louis Fed President James Bullard all but admitted this to the Financial Times:

“I am a little – maybe more than a little bit – worried about the future of central banking,” said James Bullard, president of the Federal Reserve Bank of St Louis, in a Financial Times interview at Jackson Hole. “We’ve constantly felt that there would be light at the end of the tunnel and there’d be an opportunity to normalise but it’s not really happening so far.”

The biggest worry on display at Jackson Hole was whether these bureaucrats, sitting at the heart of every mature economy, still have the power to influence demand now that interest rates cannot fall much further. Lurking behind many debates was this question: if central bank policies are so effective, why is the global economy not growing faster?

http://www.ft.com/intl/cms/s/0/a0e397b6-f8dd-11e1-b4ba-00144feabdc0.html

Here’s a Fed official, not only openly admitting that Fed policies aren’t working, but even calling the future of Central Banking into question. Take note: underlying realities are beginning to be asserted by officials at Central Banks around the globe. They’re running out of bullets.

So where does this leave us? Well, it’s highly unlikely the Fed will actually implement anything major this week. What we could see is a large, but hollow promise for action, much like the ECB’s promise of “unlimited” bond purchases based on certain “conditions” being met (an empty promise if ever there was one).

If this kind of empty promise is made, look for the market to top soon after.

And if the Fed fails to deliver this week… buckle up.

On that note, if you are not preparing for a bloodbath in the markets, now is the time to do so. The reality is that the Central Banks are fast losing their grip on the markets. They’ll never admit this publicly, but I can assure you that Bernanke and pals are scared stiff by what’s happening in the banking system right now.

If you’re looking for someone who can help you navigate and even profit from this mess, I’m your man. My clients made money in 2008. And we’ve been playing the Euro Crisis to perfection, with our portfolio returning 34% between July 31 2011 and July 31 2012 (compared to a 2% return for the S&P 500).

Indeed, during that entire time we saw 73 winning trades and only two losers. We’re now positioning ourselves for the next round of the Crisis with several targeted investments that will explode higher as the EU crumbles.

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Graham Summers