In sum, as long as core CPI inflation remains contained, and unemployment remains high, the Fed will err on the side of risking asset bubbles and relative price distortions for the sake of promoting full employment.
Having said this, Fed officials do not wish to admit explicitly that they are assuming this risk, as many of them understand how damaging asset bubbles and relative price distortions can be to the economy in the long run. This is where the Jedi mind tricks come in.
The Fed is going to tell us today that "tapering" is imminent, sending a suggestive but somewhat vague signal that the wind-down of QE has begun. This part of the message is meant to keep the bond vigilantes at bay.
At the same time, the Fed is going to say that monetary policy will remain accommodative for an extended period even after tapering has begun; QE will continue (albeit at a reduced pace) and short-term interest rates will be retained near zero. This part of the message is directed at investors concerned that growth could be derailed.
To all of this, the Fed will add a further dash of intrigue by confidently proclaiming that the Fed stands ready to reduce or increase the level of accommodation as conditions warrant (as if it were so easy for the Fed either to forecast conditions correctly or effectively to dial monetary accommodation up or down at will).
The Fed's strategy is this: Baffle the bond vigilantes with some mysterious and even contradictory suggestions that keep them guessing and paralyzed. At the same time, keep pouring in the liquidity and continue pretending there are no risks to this policy.
Folks, this is a mind trick, straight from the Jedi playbook. On Wednesday, immediately after the Fed releases its statement, I will inform my readers exclusively through my
whether The Force was with Ben Bernanke and evaluate the extent to which he was able to execute the mind trick successfully.
If the mind trick is executed well, both equity and fixed income markets should rally; if not, there will be a disturbance in The Force, and financial markets will find themselves in a considerable pickle.
At the time of publication the author had no position in any of the stocks mentioned.
This article was written by an independent contributor, separate from TheStreet's regular news coverage.