Fed Unlikely to Boost Bond Purchases

According to the WSJ, Fed officials have become more confident recently that they have stabilized the economy and set the stage for recovery.  However, divisions within the Fed remain over what to do going forward.  Should the Fed continue aggressively buying bonds?  Or step back to avoid fanning inflationary fears?  Right now, it appears as if the Fed will step back for the moment.  The problem is that nobody knows what to do.  If the Fed were any good at the Treasury trading game, it wouldn't have punted all that money buying 10-year notes with a 2% yield, if yields were just going to shoot up to 4%.  The jury is still out on whether Mr. Bernanke is a good Fed Chairman, but with his recent track record, he'd never get a job trading bonds.  Sure, the Fed isn't doing this to make money, but to boost lending in the mortgage market, but still...  Mr. Bernanke has been played by those clever traders on the Street, who don't take kindly to having their livelihoods threatened by the government.    

In his defense, Mr. Bernanke has a very difficult job.  First he had to save the economy from being demolished by the unraveling of years of unsupervised (yes, he was supposed to supervise) and reckless lending by the financial services industry.  The effects of the massive deleveraging are still being felt, as yesterday's Fed release of the Flow of Funds report revealed.  Household net worth declined by another $1.3 trillion in the first quarter, bringing the total decline from the peak to $14 trillion.   So if you're feeling less rich than you were a year ago, you're in good company.  Add this on top of back-to-back quarters of annualized GDP declines of 6% and the severity of the situation becomes clear.  

The Federal Reserve has enacted an extraordinary amount of monetary stimulus by lowering interest rates to zero, loaning trillions to the Street versus any type of collateral no matter how shoddy, and then buying mortgages and Treasuries to drive long term interest rates down as well.  But still, $14 trillion is a big number, and given the excesses in housing that still need to be flushed from the system, it's not coming back anytime soon.  The ultimate question is: will all of this cause inflation that the Fed cannot contain?  The Fed seems to think it can pull back the spigot in time to avoid runaway inflation, but given how late the Fed was to the credit crisis party, and how quickly it had to invent schemes and acronyms to combat the collapse in lending, I'm not so sure I trust the Fed.  The only thing certain is that we are in uncharted waters and nobody really knows how this is going to end.