Can The Fed Have It Both Ways?

Everyone knows that the Federal Reserve has been the main catalyst behind the rising stock and housing prices. After all, the world's most powerful central bank is now implementing its third and largest quantitative easing program. Currently, the Federal Reserve buys $85 billion per month of mortgage back securities (MBS) and U.S. Treasuries. How long can these purchases continue before they cause another bubble in the stock market.

Bond Yields And Mortgages
Bond yields on U.S. Treasuries have already begun to spike. This is likely telling investors that the Federal Reserve is already behind the curve and needs to cut back on its current quantitative easing program. Believe it or not, the bond market will usually telegraph what needs to be done before the central bank takes the appropriate action. Mortgage rates have jumped higher by 50 basis points in just the past month. This increase in mortgage rates will impact borrowing costs for many home buyers and private equity firms who have been the primary buyers of single family homes. Tens of thousands of houses have been recently bought by Blackstone Group (BX), Colony Capital, Landsmith, and other private-equity firms. This is the main reason the supply of homes has fallen dramatically over the past year.

The University of Michigan consumer-sentiment index, Friday, jumped to 84.5, this is the highest reading since July 2007. We all know what happened in October 2007 when the major stock market indexes traded at all time highs. At this time, the Dow Jones Industrial Average is trading at new all time highs so this reading in consumer sentiment could tell us that euphoria is now entering into the minds of the stock market participants. Remember what the legendary investor John Templeton used to say, markets top out on euphoria.

Eventually
The Federal Reserve chairman Ben Bernanke continues to keep the peddle to the metal when it comes to his easy-money policies. He has hinted that he may need to cut back on his recent QE-3 program over the next couple of months, but every time the stock market dips he changes his tune. Eventually, the central bank will need to take the training wheels off of the stock market, but that may not happen until the bond market forces his hand via another stock market bubble or global financial crisis.