The Taper Debate: The 'Cost' To QE Is Still Low - There Is Still No Inflation

Includes: IEF, TBF, TLT
by: Brian Gilmartin, CFA

Mainly when we write Seeking Alpha articles, we do so with security-specific issues in mind, mainly focused on valuation and upcoming earnings reports, but occasionally we like to write about a broad economic topic, particularly when we have something that might be a valid consideration for readers, that isn't being heard about in the press.

The fact is the U.S. economy is getting stronger, although when you look at the various inflation indicators, there is still not only not any tangible or worrisome inflation, but there continues to be "disinflation" or what is thought to be the continued general decline in the growth rate of inflation.

Here is a great article from Benn Steil at the Council on Foreign Relations - the most notable line in this summary is the comment from Jim Bullard about 3/4s of the way down the post that, "Inflation continues to surprise to the downside".

Despite the constant hysteria by the bubble crowd about the Fed and FOMC creating another bubble, and the unnecessary mandates of the Fed to promote economic growth and a stable rate of inflation, the fact is today, the Fed is generating both decent economic growth, and is managing to not generate any unanticipated inflation, despite what many consider to be incredibly easy monetary policy.

And therein lies the rub.

As this is being written on Tuesday morning, December 17th, 2013, the current QE3, according to the very highly-regarded Jeff Miller, who writes the weekly, "A Dash of Insight" column for, constitutes only 1% - 2% of the daily Treasury and MBS trade on any given day.

In other words, the $80 billion per day of QE3 is really a small drop in a very large bucket of Treasury activity.

The other aspect to consider is whether Ben Bernanke whose tenure will end as Fed Chairman in the next few months, would start an end to the QE process, before turning over the Chairmanship to Janet Yellen in late February - early March, 2014. Does it make sense to start tapering now and then turn over the Chairman position in 3 months ?

Finally, sentiment is decidedly tilted towards a Fed that starts to end QE. No doubt this is due to the stronger economic data, but isn't our current economic state exactly what the Fed wants i.e. stronger economic growth without inflation ? Isn't that the economic version of Nirvana ?

So what is our conclusion from an investing perspective ? We went long some TLT and IEF this morning as a trade into the Wednesday announcement. We still remain long the TBF and some closed-end muni funds for clients, but while the seeming media pressure for taper grows, I don't think there will be a material announcement until the first quarter, 2014.

The fact is there remains no inflation, and in fact the inflation rate continues to slowly drop. As we wrote last September, '13 here the Fed's policy error, particularly if you study the Great Depression history, is that the Fed changes policy too quickly.

To be clear this is a 2 -3 day trade on the TLT, IEF, and we retain our TBF short given the uncertainty during this period. The TLT and IEF are oversold and might get a technical bounce. We plan on being out of this trade by week's end, depending on what happens Wednesday night.

Our conclusion is that the Fed is going to give this economic recovery more time, although ultimately taper is inevitable.

Disclosure: I am long TLT, IEF, TBF, NUV, MEN, JRO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.