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Peng: Fed Tapering to What?

But why the taper talk then, even by Bernanke himself on Wednesday? I think three recent developments have significantly shifted the cost/benefit balance of QE and eroded the Fed control of money supply. They need to respond with corresponding (and so far unknown) flexibility. The taper talk is to condition the market to the new uncertainty in Fed policy.

First, several international developments conspired around the beginning of the year to cause of tsunami of hot money into the U.S.:

  1. The dramatic Abenomics in Japan started a wave of overseas investment , as domestic investors leaving the sinking yen (after fiscal-year-end repatriation booking profits in March) and searching for yield around the globe. A big part of that money no doubt has come to the U.S. While specific data in equities are hard to come by, Bloomberg has highlighted Japanese purchase of Ginny Mae bonds.
  2. The Cyprus template of bank bail-in with deposits, as I argued for in March and recently discussed by European Parliament , has driven a lot of Europeans, especially Russians barely escaping Cyprus, and Arabs to diversify their money away from the continent. Anecdotal evidence abounds that they have been a big part of home buying frenzy in certain areas in the U.S. in recent months.
  3. China's power transition, which officially took place in March but had been in the works for months before, has prompted a wave of money outflow. Concrete data is impossible to get, since a large part of the money is presumably illicit and, even if the money is legit, the movement of any large sum in short order could not possibly be. But stories like Chinese buying up luxury Manhattan apartments in cash surprise nobody.

Such hot money inflow could help driving up inflation, which is what the Fed desperately hopes for. But the big risk is that they're out of the Fed's control, be it the amount, the timing, the destination, or even the direction, since large events anywhere could quickly turn the tide. This adds a big uncertainty to the Fed's already troubled plans for action and communication.

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