Fed Officials Uttered Words of Taboo: Breakout of Inflation and Unsustainable Bubbles

At the recent convention “Meeting of the Federal Advisory Council and the Board of Governors”, Fed officials spoke of words that have been considered taboo by their standards (bold mine)

There are potential risks associated with current policy. The Fed’s securities purchases have reduced mortgage yields and, to a lesser extent, Treasury yields. Current low bond yields are disruptive to management of fixed-income portfolios, retirement funds, consumer savings, and retirement planning. They may encourage unsophisticated investors to take on undue risk to achieve better returns. MBS purchases account for over 70% of gross issuance, causing price distortion and volatility in the MBS market. Fixed-income investors worry that attractive mortgage-backed securities are in very tight supply. Higher premium coupons carry too much exposure to prepayments, potentially led by new government support programs for housing. Many are concerned about the Fed’s significant presence in the market. They have underweighted MBS in favor of corporate, municipal, and emerging-market bonds. There is also concern about the possibility of a breakout of inflation, although current inflation risk is not considered unmanageable, and of an unsustainable bubble in equity and fixed-income markets given current prices.

Fed officials finally admits to the growing risks of price inflation “the possibility of a breakout of inflation” and bubbles “unsustainable bubble in equity and fixed-income markets given current prices”.

But will they act? Or will the markets force them via the comeback of the bond vigilantes?

Now on the Fed’s prospective exit program:

Uncertainty exists about how markets will reestablish normal valuations when the Fed withdraws from the market. It will likely be difficult to unwind policy accommodation, and the end of monetary easing may be painful for consumers and businesses. Given the Fed’s balance sheet increase of approximately $2.5 trillion since 2008, the Fed may now be perceived as integral to the housing finance system

In short the Fed impliedly admits that a withdrawal of the easing environment would mean that the current boom will turn into a “painful for consumer and business” bust.

As the Zero Hedge quips “Uhm... wow.”