In September of 2012, Priya Misra, Senior Researcher for Bank of America, stated that the Fed will continue purchasing $85 billion per month in assets throughout 2014 (due to a weak labour market in the US). In an interview from January of this year (link is at the bottom of this report), she reiterated her stance that the Fed will not change its policy and that its key lending rate will remain near zero until late 2015. So far, she has been pinpoint accurate.

To give you some background on Priya, she was ranked in the top three for government debt analysts in Institutional Investor's All-America Fixed Income Research team surveys from 2003 to 2008. Her opinion carries major weight.


The Fed's Misstep

While the Fed has hinted at prolonged quantitative easing in the past, it made the mistake of spooking investors in May with some tough talk about concluding its asset purchases. Now that we've seen the head fake, it's unlikely the Fed will even bother mentioning the idea of ending asset purchases anytime soon; its agenda has been crystalized. Gold, oil and equities have been the near-term beneficiaries of the Fed's exposure.

The Fed Controls North American Economy

The Fed's policies and key lending rate is very relative to Canadians. The Bank of Canada opted to hold its benchmark lending rate at 1% last week. This was the first rate announcement for the new Bank of Canada Governor, Stephen Poloz, since taking over from Mark Carney. The Bank of Canada will have a very difficult time raising rates, so long as the Fed maintains its current course, as it would surely send the Loonie higher vs. the Greenback.

This competitive devaluation, meant to spur job growth specifically aimed at the manufacturing sector, has been the perfect scapegoat to allow the easy money to continue flowing in Canada. Many argue that raising the key lending rate would hurt Canada's largest corporations (as Canadian exports would become more expensive for our largest customer - the US) and thus create a potential recession. Much like the US, Canada's economy - outside of Alberta - is also limping along with relatively unimpressive growth; so the case for low rates is easily made.

While there is a strong case for continued record low interest rates on both sides of the border, do not get sucked into borrowing and/or spending more than you can afford. Household debt is at record highs in a number of provinces and is setting us up for yet another credit crunch. Do not let the Fed's easy money policy bring you down over the long-term.

This Environment Won't Last Forever

The Fed cannot keep this game going forever. When the US CPI rate ticks up to around 3%, the Fed will be forced to raise rates; either that or it will have to fudge the CPI rate by stating a lower figure and flat-out lie to the public (a la China).

If Bank of America's Priya Misra is correct, and the Fed maintains its current level of bond and mortgage backed security purchases, its balance sheet will exceed $5 trillion by the end of 2014.

The Fed's balance sheet, as of July 17th 2013, stands at $3.53 trillion.

Federal Reserve Total Balance Sheet - 6 Year Chart

chart source: The Federal Reserve

In September of 2012, Zerohedge.com came out with an article titled, The Fed's Balance At The End Of 2013: $4 Trillion. Zerohedge projected the Fed's balance sheet as a percentage of GDP in the chart below:

If Priya Mirsa is correct with her predictions, and the Fed continues purchasing assets at this pace, it will have acquired, and subsequently leveraged, roughly 25% of US GDP by the end of this year! And over 30% of US GDP by the end of 2014! The Fed is buying an unbelievable amount of American assets. It's akin to an exercise in nationalization.

Below is an excerpt from the Zerohedge article which sums up the predicament the Fed and US government will soon find themselves in:

When the Fed ultimately reverses course and begins to remove these assets from its balance sheet, who will be the buyer?

Who will want to buy the millions of toxic, underwater mortgages that banks are currently offloading to the Fed?

The Predicament

The Fed could create its own liquidity crisis when/if it is unable to sell its bonds or mortgage backed securities in an orderly manner. It will literally need another Fed to come in and start buying up its balance sheet! As outrageous as it sounds, that is effectively what the US central bank has been doing for the US Treasury Department for years. This makes one wonder if the Fed ever plans on shrinking its balance sheet down the road. It may not be possible without creating a crisis.

When the Fed buys Treasury bonds it creates false demand (stabilizes the market by manipulating rates) and increases the money supply (this is inflationary). The Fed has been waiting patiently for years for the velocity of money to pick up. When money velocity picks up, look out, because inflation is going to hit the market in a big way (click here to read our report from March titled The Velocity of Money: The True Measure of an Economy's Health). If the velocity of money increases to historically average levels, investors will be shocked at how quickly the inflation rate will rise (thanks to all the Fed's intervention).

Drowning in Debt

The US is projected to pay over $400 billion in interest this year alone on its $17 trillion in national debt.

The math just doesn't add up, which is why many forecasters truly believe the Fed is targeting an all-out collapse of the dollar, through a period of hyperinflation. This would relieve the country from much of its previous debt obligations.

The Fed is pursuing a furious course of inflation. In regard to monetary policy and the amount of debt one nation has tried to overcome, we are in uncharted territory. No economist or analyst, no matter how studious, knows exactly how this great experiment will play out.

Keeping some of your financial wealth in assets that tend to outperform in a period of inflation is only prudent from our point of view. Those assets relate to oil, silver, gold and real estate.

All the best with your investments,