Enjoy the Federal Reserve’s “Punch Bowl” While It Lasts

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If you’ve ever hosted a party, you know that one of the best ways to get rid of unruly, unwanted guests at the end of the night is to take away the alcohol.

Personally, I’ve never tried this. I’m too nice of a guy.

In monetary policy, “taking away the punch bowl” refers to a central bank action to reduce the stimulus, and thereby stop the party.

The term was coined by Federal Reserve Chairman William McChesney Martin Jr., who sat at the head of the Fed table from 1951 to 1970.

Martin’s party pooper successors heeded his advice.

When the economy started to heat up, Fed Chairs Paul Volcker, Alan Greenspan, Ben Bernanke and Janet Yellen raised interest rates to tamp down economic growth and ward off the threat of inflation.

They were often criticized for taking away the punch bowl too soon.

Apparently, current Fed Chairman Jerome Powell is a more gracious host. In breaking from precedent, he’s igniting what I’ve called the “mother of all bubbles.”

And last week, Powell confirmed my thinking: We are only about midway through this epic fiesta.

The Fed Replaced the Punch Bowl With a Jacuzzi

In early April, I saw the writing on the wall.

Even in the face of a 35% market correction and unemployment rising to over 20%, everything was changing.

In the decade since the financial crisis, I have been watching the Fed’s every move, poring over Fed speeches and meetings for clues on the direction of interest rates and market movements.

In the past, the Fed has targeted 2% inflation. When it looks like employment is running hot and inflation starts to creep up, it has been quick to stop quantitative easing (buying bonds to increase the money supply), reduce its balance sheet and raise rates.

However, in early April, the Fed changed its tune.

Jerome Powell assured us the Fed was “committed to using its full range of tools to support households, businesses and the U.S. economy overall.”

In previous rounds of quantitative easing, the Fed bought vast quantities of U.S. government bonds and mortgage debt backed by government agencies such as Fannie Mae and Freddie Mac.

This time, however, it promised support for debt issued by companies, state and local governments and other entities, although it did stop short of buying municipal debt directly.

The Fed replaced the punch bowl with a Jacuzzi spiked with grain alcohol. But that wasn’t the end of it.

The Party Will Continue Longer Than Everyone Expects

In late August, Powell changed the Fed’s approach to targeting inflation.

The Fed will no longer be a proactive inflation fighter that takes away the punch bowl too soon. It plans on letting the economy run hot to make up for past shortfalls.

It also maintained that if unemployment falls close to zero, it will extend more of the gains to minority and lower-income groups.

Last week, the Fed reiterated this posture and voted to continue purchasing $120 billion of securities a month.

Since the end of February, the Fed’s balance sheet has jumped from $4.1 trillion to $7.1 trillion.

This means it has replaced $3 trillion of bonds with dollar reserves on bank balance sheets. This is money that can be used for loans to purchase homes, cars and businesses.

Knowing that the Fed now has our backs soothes the market’s worry about a divided Congress and the lack of a stimulus package.

This won’t last forever. At some point, every party ends, the lights come on and investors worry about their regretful decisions.

But the Fed has pretty much ensured that this one will continue longer than everyone expects.

So, grab another drink and enjoy it while it lasts.

Regards,

Ian King

Ian King

Editor, Automatic Fortunes

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