Taper or not, here come higher rates
I have been discussing the likelihood of the Federal Reserve tapering sooner rather than later given the favorable economic data and employment trends that exist and have existed even in the face of the government shutdown. My analysis and observations also define the triggering catalyst for the Fed to be interest rates rather than any other external or uncommunicative catalyst that economic pundits might otherwise suggest.
My discussion has been quite firm suggesting that the Fed would not risk damaging the economic environment it has worked so hard to stabilize by tapering at relatively high levels of interest in the 10-year Treasury bond. This was the same reason the Fed decided not to taper in September. Interest rates were spiking at that time, housing had started to slow, and general economic activity was being impaired by interest rates that had already begun to move higher. The Fed, in September, decided not to taper because they did not want to piggyback those already high interest rates.
I have been clear about this before, but there is something more to add.
I continue to believe that if interest rates are at relative highs when the Federal Open Market Committee meets again in December, they will not taper. Given the changes in interest rates that have taken place over the last few days alone, I would also suggest that if the FOMC was meeting today, that they would not taper either. The only chance for tapering, in my opinion, is if interest rates pull back to a level that is determined to be more reasonable by the FOMC.
(Read more: By not tapering, Fed actually increased stimulus)
The Fed doesn't want to run the risk of dampening economic activity by increasing interest rates even more by tapering their asset purchases but that also leaves the economy and any asset class that has been supported by the cheap money environment in question. The conundrum pits higher interest rates against tapering in such a way that might actually be a moot point because either of these two could equally dampen economic growth.
If the Fed decides to taper, it will be doing that because interest rates are at a reasonable level and they believe the spike in interest rates that will likely occur when tapering happens will not be as detrimental as it would be if they piggyback on already high interest rates. Tapering will cause interest rates to increase and it will remove liquidity from the system while putting pressure on asset classes that have been depending on the same.
(Read more: Fed's Fisher: QE won't go on forever)
However, if the Fed doesn't taper, it will be because interest rates are already at high levels and they don't want to run the risk of making an already concerning interest-rate environment worse. If the Fed decides not to taper, the higher levels of interest rates that will deter them will also already exist and they will already be acting as a headwind to economic growth and the asset classes that have been relying on cheap money will be affected.
The situation at hand does not provide any way out of a higher interest-rate environment. Quite the opposite: If the Fed decides to taper, it will act as a headwind; if they continue on their course of action and refrain from tapering because interest rates are higher than they would like, that already higher interest-rate environment will already be acting as a headwind to economic growth as well.
(Read more: Yellen more dovish than Bernanke: CNBC survey)
Therefore, for asset classes that are dependent on cheap money, there is no way out immediately. One way or the other, interest rates are going to increase — probably between now and the end of November. It will either happen because the Fed decides to taper or it will happen naturally in the bond market like it has already begun to do. Either way, a higher interest-rate environment will act as an impediment to economic growth, general liquidity, and quite likely the stock market itself.
— By Thomas H. Kee, Jr.