No More Free Lunch

The Fed’s experiment of pouring trillions of dollars into the markets is coming to an inglorious end. Even though an accelerated taper will still results in hundreds of billions in additional liquidity over the next several months, the writing is on the wall.

Allianz Chief Economic Advisor Mohamed El-Erian said it well yesterday on CBS’ “Face the Nation.”

“The characterization of inflation as transitory is probably the worst inflation call in the history of the Federal Reserve, and it results in a high probability of a policy mistake. So, the Fed must quickly, starting this week, regain control of the inflation narrative and regain its own credibility. Otherwise, it will become a driver of higher inflation expectations that feed onto themselves.”

I agree wholeheartedly, though we might differ on whether the Fed’s actions to date have been a “mistake.” In my view, they were taken with the certain knowledge that inflation would be driven much higher – an outcome the Fed must have deemed acceptable even though the brunt of it would obviously fall on the poor and middle class.

The correction in oil & gas prices is a good start, but it will take much more.

Higher oil and gas prices, a weaker dollar, ludicrously low interest rates – all contributed to the stock market being where it is today. Without those factors, major indices, commodities and housing prices would be far lower.

Years from now, economists might debate whether inflating another huge asset price bubble was worth it. But, for now at least, the Fed must figure out how to tap the brakes without causing a pileup among all those tailgating investors.

Futures are flat as we approach the open.But, this week should see substantial moves in equities, currencies, commodities and yields.

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