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Has the Fed reached the Apex of its ability to control markets?

First, we must understand that, as a Washington institution, the Fed is a political animal. Like all political animals, it is interested, first and foremost, in maintaining its power and influence. Thus, it is not likely to embark on actions that it feels may threaten that status.

This is important in the context of last Tuesday's election results. While generally viewed as favorable by the street, the Republican takeover of the House and gains in the Senate were led by a slightly different class of lawmaker with a decidedly populist tone.  In addition to the obvious and already promised focus on fiscal discipline and government spending cuts, we are already seeing increased pressure on the Fed regarding its extremely loose monetary policy. Ron Paul will chair the House committee overseeing the Fed and will be dogged in his drive to increase oversight, transparency and control of the Fed.  Seen today from Sen. Corker and others, there is already talk of removing full-employment from the Fed’s mandate.
Additionally, the voting composition of the Fed will change beginning with the January 2011 meeting, with the hawkish heads of Philadelphia, Dallas and Minneapolis becoming voting members. (current hawk T. Honeig of KC does drop out of the voting). Add this to the recently aired QE2 doubts of Mr. Warsh and you have an entirely different dynamic on the FOMC.
Finally, we have seen a worldwide political backlash against QE2. Domestically, the realization that the new round of asset purchases will effectively finance 100% the federal deficit over the next 8 months has created a firestorm of criticism of Fed support for fiscal irresponsibility. Internationally, criticism of the program as thinly-veiled currency manipulation has been heard from all of the major world economies.
The Fed must have seen the above dynamics coming and decided to act in spite of them. The question is why?   We all know the publicly stated reasons regarding growth being too slow and unemployment being too high (and now the explicit admission that they are attempting to support the stock market and create a “wealth effect”). In my view, these justifications are for public consumption purposes… the real aims of QE2 are completely unpalatable politically. When the public is thrown so many seemingly inconsistent justifications for the fed’s actions, it means one of two things in my mind: 1. The Fed is just really, really myopic and/or plain stupid or 2. They are obscuring their real motivations. They just can't be that dumb. What we really have is a veiled attempt to prop up the financial system at the expense of savers, retirees, and the fixed income dependents.
Let’s look at the likely real motivations: first in my mind is bank solvency and profitability. The Fed (as the main regulator of banks) knows the banks are in massive trouble. Set aside all of the obvious exposure to RE loans, the consumer, the MBS and foreclosure problems and consider CDS and counterparty default exposure. In my mind, this is the primary reason that an outright default of a major bank or sovereign will be avoided at ALL costs.  This is something very few are really talking about, but IMHO is the major reason why the Fed and the ECB will stop at nothing to prevent a Greek, Irish or other sovereign default. The problem is one of interconnectedness and concentration risk. The major banks in Europe and the US are all exposed to each other as CDS counterparties with default insurance contracts in the trillions (notional value) written on each other and on various sovereigns. Ask yourself this: who are the most likely writers of those contracts? (the banks themselves) and are they likely to be adequately reserved against the potential payout on a sovereign default (not even close...AIG was nowhere close when Lehman CDS brought them down). These are all carried as "off-balance sheet" obligations, so are not even factored into the official leverage ratios, which approach 50-1 in the Eurozone.
Two other goals of QE2 are dollar devaluation aimed directly at the RMB peg and the treasury's need to finance the deficit.  The latter of those two leads to the next question: can the Fed indefinitely control the markets? Will they lose control of bond yields? We have already seen rates at the long end rising across the board even in the face of telegraphed Fed buying. The last few days have seen a major move, especially in the long-end of the curve.
Worldwide policy response over the last few years has essentially just papered over almost everything that led us into the crisis. This is true with respect to money printing as well as regulatory forbearance. Instead of using the time bought with these policies to make the needed structural adjustments, the fed is now trying to fuel the same misallocations of capital and mispricing of risk. We have made insolvent institutions even larger and more important and still haven't owned up to real FMV's....I must admit I misjudged the level of discipline the fed would show. 
The dangerous dynamic for equities is that the Fed IS the market. They started QE1 in March 2009 and the market levitated for a year until they stopped buying on April 1, 2010. The market tanked 3 weeks later and did not recover until the fed started QE lite and QE2 in August/Sept. 2010. There is little to no bid under the market without the Fed, which leads to the obvious question: how do they ever exit? The recent sell-off in bond and equity markets into the face of major Fed asset purchases has to make one question whether they have reached their apex of control over the markets.