Fed Signals Major Policy Shift

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by Mike Larson,

from Money & Markets,

Heads up everyone! We could be on the cusp of yet another major policy shift from the Federal Reserve. And if you remember the massive “Taper Tantrum” from last year, you know just how important that could be.

Why am I making such a huge, important market call here? It all goes back to what I’ve been writing for a while. I told you in no uncertain terms that many indicators of market complacency and risk-taking have gotten as bad — if not worse — than they were in 2006-07, and before that, 1998-99. Those two periods in market history marked massive turning points — from big gains in risk assets and massive complacency in markets … to the polar opposite.

Now, other analysts are saying the exact same thing. More importantly, policymakers at the Federal Reserve — the very policymakers who caused this situation in the first place — are finally chiming in too!

First, the Wall Street Journal published an article late in the day Tuesday titled “Fed Wary of Market Complacency.”

Dallas Fed President Richard Fisher

Second, in addition to the Journal article, two Fed policymakers grabbed the microphone this week to warn that 1) Interest rates will likely need to rise sooner, and by a larger magnitude, than observers believe and 2) Volatility is way too low and complacency is way too high.

Back in the old days, investors wouldn’t care as much about the Fed’s warning on complacency or market volatility. That’s because the Fed had only two official policy goals: Keep inflation as low as possible and employment as high as possible.

But the credit, housing and mortgage crisis changed everything. The Fed completely missed the mark there, failing to foresee and head off the biggest financial and economic crisis since the Great Depression. So now it knows that to cover its political backside, and to actually try to get things right for a change, it needs to take action to keep risk taking from getting any more out of control than it already is.

Bottom line: We already had enough decent economic data, and worrisome news on the inflation front, to tilt Fed policy in a more hawkish direction. Now — on top of that — we have the Fed saying that it’s worried about excess complacency and excess risk-taking.

That means we’re facing a new, clear and present danger … the danger that policy gets even tighter, with more aggressive tapering of QE, earlier-than-expected or bigger-than-expected interest rate hikes, or both.

So if you haven’t already done the following, do so now:

First, get the heck out of long-term bonds.

Second, take some profits on stocks

Third, favor the U.S. dollar versus the euro.

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