There has been a lot of talk in the media (including from me) about the effects, both positive and negative, of the Fed's aggressive monetary easing programs
We are in the camp that believes Fed's support was unquestionably needed during the throes of the crisis in order to avoid a complete financial collapse.
However, the continued aggressive monetary support from the Fed has led to some serious concerns, at least on our part.
Our major concerns, as we have articulated in past market commentaries, are that 1) the Fed's actions can cause commodity price inflation, which can be counterproductive to the recovery; 2) the Fed's policies can cause asset price inflation, leading to the threat of asset bubbles; and 3) both the economy and capital markets have become heavily dependent on continued aggressive Fed actions, potentially creating a problem of moral hazard (particularly in the stock market).
Our overriding fear is that the Fed will find it very difficult to extricate itself from the situation of dependence it has created. And while stabilization in housing prices and huge gains in stocks feel good at the moment, this could all change very quickly. The Fed cannot simply manipulate interest rates and grow its balance sheet indefinitely. What is the exit strategy? When does it begin?
In an effort to better understand the effects of the Fed's monetary policy, we constructed a timeline of major Fed developments and tracked key economic metrics. We tracked five metrics or indices: the Dollar Index , the price of oil , a commodity index, the S&P 500 , and the yield on the 10-year Treasury note .
Our starting point was the announcement date of the Fed's first quantitative easing program ("QE1"), and our ending point was late February of this year. The rather busy chart below shows the results of our analysis. The boxed annotations represent key developments at the Fed. The shaded gray areas on the chart represent periods during which the Fed had withdrawn QE support only to return later with more QE. Take a minute to review the chart, and we will try to draw some conclusions below.