Courtesy of ZeroHedge. View original post here.
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Perhaps the most important thing to understand about what was widely billed as the most important FOMC decision in recent history, is that by “removing the fourth wall” (to quote Deutsche Bank), the Fed effectively reinforced the reflexive relationship between its decisions, economic outcomes, and financial market conditions.
In simpler terms, differentiating between cause and effect is now more difficult than ever as Fed policy affects markets which in turn affect Fed policy and so on.
This sets the stage for any number of absurdly self-referential outcomes.
For instance, the Fed needs to remain on hold to guard against the possibility that a soaring dollar triggers an EM meltdown that would then feed back into developed markets, forcing the FOMC to reverse itself. But delaying liftoff sends a downbeat message about the state of the US economy which triggers the selling of domestic risk assets. Hiking would solve this as it would signal the Fed's confidence in the outlook for the US economy, but that would be USD-positive which is bad news for EM.
A similarly absurd circular dilemma presents itself if we take the view that the Fed missed its window to hike and is now creating more nervousness and uncertainty with each meeting that passes without liftoff. Here’s how former Treasury economist Bryan Carter put it to Bloomberg: "short-end rates move higher as the Fed gets closer to hiking, and that causes the dollar to strengthen, and that causes global funding stresses. They are creating the conditions that are causing the external environment to be weak, and then they say they can’t hike because of those same conditions that they have created."
When you tie the reflexivity problem in with the fact that the excessive use of counter-cyclical policy is leading to the creation of ever larger asset bubbles by effectively short circuiting the market's natural ability to purge speculative excess and correct the misallocation of capital, what you get is a never-ending loop whereby the consequences of unconventional monetary policy serve as the excuse for doubling and tripling down on those same policies.
It's with all of the above in mind that we present the following flow chart from RBS' Alberto Gallo who illustrates the "QE infinity paradox":
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What we now have is another data point which outlines the contours of the Fed reaction function. Fed’s communication strategy, it is becoming clear, is an equivalent of what in theater context is referred to as Removing the fourth wall whereby the actors address the audience to disrupt the stage illusion — they can no longer have the illusion of being unseen. An unalterable spectator becomes an alterable observer who is able to alter. The eyes are no longer on the finish, but on the course — what audience is watching is not necessarily an inevitable self-contained narrative. The market is now observing itself from another angle as an observer of the observer of the observers.
