What's the Fed's next move

Wed, 23 Jun 2010 01:34:00 GMT

With the stock market up over 50% last year, talk of a V shaped recovery, green shoots, and other aberrations, most analysts expected the economy to resume growing as if 2008 was some sort of unpredictable outlier. With interest rates at 0, and massive government spending programs, the biggest concern for mainstream media was that the economy might grow too fast.

However, it seems evident that even the Federal Reserve doesn't believe in the green shoots theory anymore. Despite government intervention, economic indicators are rolling over, money supply measured by M3 is declining, and financial stress is increasing. Europe is now in an economic crises that could easily spread, and oil is filling the Gulf of Mexico. Risks of a shock to the financial system are everywhere.

Some analysts have been arguing that interest rates must rise to compensate bond holders, however the European crisis has been a gift to the dollar and treasuries so interest rates have remained low. A spike in interest rates appears unlikely in the near term.

If the current trajectory continues, there could be another sharp correction in equity markets globally but US assets may perform the best in comparison, especially treasuries. This could trigger another bout of financial asset deflation and panic. But what can the Fed do now that interest rates are at 0? Will Robert Prechter finally be right after so many years?

Unlikely.

The Fed will never be out of bullets as long as there is a fiat currency - for better or worse. The Fed would probably resume quantitative easing programs on an astronomic scale. And it might even work for a while.

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What's the Fed's next move