The Path to the Great Egress

Instead of P.T. Barnum, now we have Federal Reserve Chairman Ben Bernanke trying to mark a clear path to the exits. With his semiannual testimony to Congress and an op-ed piece in the Wall Street Journal, Chairman Bernanke is going to great lengths to reassure market participants that the Fed will know when to put on the brakes and withdraw the trillions of dollars in liquidity from the system-so as to avoid either creating rampant inflation or sowing the seeds of yet another asset bubble. Some of the Fed's programs are temporary in nature and will unwind on their own over the next several quarters; however, with rising unemployment, moribund industrial output and a rapidly-deteriorating commercial real estate sector, broader economic conditions point to a good chunk of these trillions staying in the system and interest rates remaining close to zero for the 'foreseeable future'.

Ultimately, this creates a huge problem of timing for the Fed and will test its mettle: withdraw too soon and tank the economy or leave the liquidity in or short-term rates too low for too long and create the modern-day equivalent of the Weimar Republic. Add on to these scenarios a possible shift in inflation expectations and you have a serious increase in the degree of difficulty for the Fed to manage monetary policy decisions. As a result, the Fed will need a healthy dose of luck when its exit strategy is implemented in order to keep inflation in check.