Free markets, however, are not designed to be on railroad tracks no matter how smoothly the switches are tapered. Nor do they wait for point indicators to tell them which way the switch will direct them. Rather, participants in free markets invest in making better binoculars than their competitors so they can see which way the track is going in the distant future. When they think they know, they jump off the rails hoping to be the first ones to the new course.
There is a saying on Wall Street: "Don't fight the Fed." Experience shows that investors who bet against the Fed ultimately lose. If the Fed wants yields to drop, they will likely accomplish their objective. If they want yields to rise, they will likely accomplish their objective.
As a result, their policy decisions elicit a binary response – investors either buy or sell. This has been evident in the big price swings in assets across the globe this year. It is this reality which will necessarily make the transition to new tracks anything but smooth.
In response to volatile markets, the Fed will likely be forced to continuously modify their switch. Most likely, they will be compelled to reduce their asset purchases more slowly in hopes of keeping an interest rate shock from quelling the nascent rebound in housing and consumer confidence. If they do, the markets will jump from their rails again.
While a change in the plans will necessarily create volatility, the real issue is that the markets have to get back to setting their own course. Like many things in today's policy world, Washington has chosen to give the markets a ride to their destination rather than letting them find their own way.
Unless the U.S. wants to abandon free markets, the Fed has to quit laying track at some point. More importantly, they need to quit laying tracks because only then will the risks of excessive debt, bad fiscal policies, unfundable future promises, regulatory overreach, and convoluted tax rules be evident.
A change of course is at hand. It is a new world in which volatility will be present. It is a new world in which investors must be brave.