The Bullion Bank Reports: The Bond Bubble Must Go On

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Why the Fed is More Likely to Increase QE Than Taper

The Bullion Bank

A dropping official unemployment rate will not be enough to offset a declining labor participation rate, already rising interest rates (5), dumping of bonds by foreigners and Bernanke’s own selfish motivations.

Quantitative Easing was started in order to provide liquidity to the faltering banking system. The Fed purchased the distressed assets that riddled the balance sheets of the big banks, all the while suppressing interest rates hoping for economic stimulus as a side effect of cheap borrowing. Over the last few years, 7 and 8 percent unemployment became the norm and the Fed promised to keep easing until that rate dropped below 7%. Recently, the official unemployment rate ticked down to 7.3% (1), and the Fed has hinted at slowing down the purchase of assets. However a stronger economy is not the real reason for a drop in the unemployment rate, but a labor participation rate at a 35 year low is. (2) As a side effect of QE, the Fed has blown the biggest bond bubble in recent history, and the show must go on.

The only way interest rates can stay low, and bond prices can stay high, is if the Fed keeps buying them at a steady rate, all else being constant. However, not everything else remains constant as foreigners like Japan and China have been dumping US bonds since June. (3) This means that to keep rates constant, not only would the Fed have to continue pace, but increases purchases to make up for gap left by foreigners.

With Ben Bernanke’s shift as Fed chairman coming to an end January 31, 2014 (4), he will do everything in his power to ensure smooth sailing and a clean legacy. His incentives will be less political and economic and more selfish as he looks to save his reputation. Tapering too soon could lead to a collapse a bond, and equity markets, which is more than the departing economist will care to leave on his resume. The market is already factoring in anticipation of tapering

A dropping official unemployment rate will not be enough to offset a declining labor participation rate, already rising interest rates (5), dumping of bonds by foreigners and Bernanke’s own selfish motivations. If QE taper does start, don’t expect it to last long.

1. http://www.bls.gov/news.release/empsit.nr0.htm
2. http://www.bloomberg.com/news/2013-09-09/unemployment-falling-for-wrong-reason-creates-fed-predicament.html
3. http://seekingalpha.com/article/1676772-china-and-japan-dont-want-our-bonds
4. http://www.federalreserve.gov/aboutthefed/bios/board/bernanke.htm
5. http://finance.yahoo.com/q?s=^TNX

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