The Federal Reserve is charged with managing our money system, and by association, much of our economy. It is therefore of the utmost importance the Fed maintain a high level of credibility in this important role.
In 2008, the world experienced a true economic calamity in the form of the global credit crisis. I now believe most of us will fortuitously never know the potential depth of the crisis, but its scope and nature clearly scared those charged with managing our financial system, and this definitely included the Fed.
In response, the Fed embarked on some highly aggressive counter measures to limit the scope of the crisis. Whether as a result of these counter measures, or because the scope of the crisis was overestimated or just maybe because the American people and economy are simply incredibly resilient, we did not sink into a Great Depression. Five years later, after a really nasty recession, our economy seems to be gaining traction. Bottom line, we survived.
But remember all those aggressive counter measures? They don’t simply go away on their own; they have to actually be unwound by the Fed. The time to start this unwinding process has arrived, and the financial markets are nervous.
I believe the markets are at least partly nervous because the process of unwinding is so large and full of peril it is likely the Fed will misstep at some point, and these missteps could actually have the potential to undermine the credibility of the Fed itself.
In order for the Fed and our money system to function, we all have to believe the system can be somewhat managed. If markets lose faith in the ability of the Fed to manage the process of unwinding its aggressive counter measure programs, the impact on stock and bond prices could be harsh.
Our economy is starting the final stretch on its road to recovery; unfortunately this final leg has the potential to be a bumpy part of the journey. Investors are demanding the Fed provide an effective road map showing how it is going to bring us home.
The Fed had the opportunity to provide some guidance this week when it released its recent meeting minutes; the information released fell far short.
The next opportunity to gain some insight comes this week while the Fed conducts its annual Jackson Hole symposium. Investors will be closely watching, looking for insight.
I believe there is a good chance the Fed will be successful in the unwinding process, but the front end of this process is almost sure to be messy. I am comfortable with taking a wait and see attitude before I make any additional portfolio changes at this point, but its time for all investors to paying close attention.