FRB-Dallas President Richard Fisher in a 3/5 speech before the Association of Mexican Bankers in Mexico City warned that the Fed’s ultra-easy monetary policy is inflating speculative bubbles again in the financial markets:

To add insult to injury, there are increasing signs quantitative easing has overstayed its welcome: Market distortions and acting on bad incentives are becoming more pervasive. Stock market metrics such as price to projected forward earnings, price-to-sales ratios and market capitalization as a percentage of GDP are at eye-popping levels not seen since the dot-com boom of the late 1990s. In the words of James Mackintosh, writer of the Financial Times column ‘The Short View,’ a not insignificant number of stocks in the S&P 500 have valuations ‘that rely on belief in a financial fairy.’ Margin debt is pushing up against all-time records. And, in the bond market, narrow spreads between corporate and Treasury debt reflect lower risk premia on top of already abnormally low nominal yields. We must monitor these indicators very carefully so as to ensure that the ghost of ‘irrational exuberance’ does not haunt us again.

Fisher is a voting member of the FOMC this year. He is the only participant of the committee with real-world rather than academic experience working in the capital markets. According to his bio: “In 1987, Fisher created Fisher Capital Management and a separate funds-management firm, Fisher Ewing Partners. Fisher Ewing's sole fund, Value Partners, earned a compound rate of return of 24 percent per annum during his period as managing partner. He sold his controlling interests in both firms when he rejoined the government in 1997.” Let’s have a closer look at Fisher’s list of speculative bubble indicators:

(1) Financial fairy valuations. The Fed released its quarterly Flow of Funds report last Thursday. It showed that the market value of all equities traded in the US soared to a record $34.7 trillion at the end of last year, up a whopping $20.9 trillion since the start of the bull market during Q1-2009. As Fisher notes, total stock market capitalization as a ratio of nominal GDP rose to 1.25 at the end of last year, exceeding the previous 2007 peak of 1.12 and the highest since Q3-2000. The price-to-sales ratio of the S&P 500 rose to 1.54 at the end of last year to the highest reading since Q1-2002.

Fisher didn’t mention Tobin’s Q, which is another valuation metric that can be calculated using data in the Flow of Funds report. It is the ratio of the market value of equities to the net worth at market value of nonfinancial corporations. I adjust it by dividing it by the average ratio since the start of the data. It was 1.44 at the end of last year, the highest since Q2-2001.

(2) Record margin debt. I’m puzzled by Fisher's comment that margin debt is “pushing up against all-time records.” It’s actually been setting new record highs since July 2012 and was at $451.3 billion during January, exceeding the July 2007 peak by 18.3%.

(3) Narrow corporate spreads. The yield spread between high-yield corporates and 10-year US Treasuries was just 280bps on Friday. That’s the lowest since the lows of early 2007, just before the financial system started to come unglued.

(Based on an excerpt from YRI Morning Briefing)

In an article in the 3/9 Quarterly Review of the Bank for International Settlements, Andrew Filardo and Boris Hofmann review the implementation, effectiveness, and risks of the NZIRP (near zero interest rate policy) forward guidance of the four major central banks: the Fed, the BOJ, the ECB, and the BOE. They write that while “forward guidance has been helpful in clarifying policy intentions in highly unusual economic circumstances …. the mixed evidence concerning the effectiveness of these practices, and the challenges they raise, caution against drawing firm conclusions about their ultimate value.”

The BIS economists stress that the effectiveness of forward guidance depends on the credibility of the central bank’s commitment to it and to clear communication of the policy. They warn:

However, if too complex, conditionality may end up confusing the public and leading to conflicting interpretations of policy intentions, with the risk of disruptive market reactions. Central banks then face the risk of getting involved in continuous discussions with the media and other observers about nuanced wording and technical details.

This is a significant risk faced by the FOMC in amending its guidance.

A related risk is “committee cacophony in external communication can further undermine the clarity and credibility of forward guidance.” That’s been an ongoing problem with all the divergent views expressed in the all-too-frequent speeches by the members of the "Federal Open Mouth Committee."

Of course, one of the biggest risks of NZIRP forward guidance is that this policy is prone to inflate speculative bubbles:

[P]erhaps more importantly, forward guidance can indirectly create financial stability risks if monetary policy becomes increasingly concerned about adverse financial market reactions (also referred to as the risk of financial dominance). At the current juncture, this could translate into an undue delay in the speed of monetary policy normalisation and raise the risk of an unhealthy accumulation of financial imbalances. Moreover, the mere perception of this possibility, over time, could encourage excessive risk-taking and thereby foster a build-up of financial vulnerabilities.

There are already plenty of signs that this is starting to happen. If the bubbles get bigger and burst, the central bankers will have no excuses given the timely forward guidance provided by this excellent warning from the BIS.

In her testimony on Thursday, Yellen blamed the weather for the recent batch of “soft data.” She said, “We have seen quite a bit of soft data over the last month or six weeks. We need to get a firmer handle about how much of the softer data can be explained by the weather.” Nevertheless, she also said that the job market’s recovery is “far from complete.” She said she expects Fed policies to favor low interest rates “for quite some time.”

Then again, she strongly suggested that the recent decline in the unemployment rate may be a more accurate indicator of a tightening labor market than previously thought. Many economists have said that the falling labor force participation rate (LFPR) may be exaggerating the improvement in the unemployment situation. Last Thursday, Yellen said that the drop in the LFPR in recent years may be more structural than cyclical:

A significant part of the decline in labor force participation is structural and not cyclical. Baby boomers are moving into older ages where there is a dramatic drop off in labor force participation and (with) an aging population we should expect to see a decline in labor force participation... There is no doubt in my mind that an important portion of this labor force participation decline is structural. That said, there may also be, and I am inclined to believe myself based on the evidence--that there are also cyclical factors at work. ... There is no sure-fire way to separate that decline into those components.

She might be right, but the data tell a complex story. The LFPR peaked at a record high of 67.3% during January 2000. The big drop occurred since November 2007, which remains the record high for the household measure of employment. Since then, the LFPR has plunged from 66.0% to 63.0% at the start of this year. We’ve been tracking the underlying data in our Labor Force Changes Since November 2007. Here are some of the latest highlights drilling down by age groups:

(1) Working-age population. Since November 2007, the working-age population is up 14.0 million, yet the labor force is up just 1.6 million. The number of people not in the labor force rose 12.4 million.

The aging Baby Boomers are having a big impact on the age distribution of the working-age population. Since November 2007, the fastest-growing group is the 55- to 74-year-olds, up 12.6 million. The 35- to 54-year-olds group is down 3.5 million.

(2) In the labor force. The weak 1.6 million increase in the labor force since November 2007 can be explained mostly by the loss of 4.9 million workers in the 35- to 54-year-old group, offset by a gain of 5.7 million in the 55- to 74-year-olds.

(3) Not in the labor force. That older group tends to have a high labor force dropout rate due to retirements. Indeed, 6.7 million more of them were not in the labor force since November 2007 through January of this year.

On the other hand, that still leaves 5.5 million people younger than 55 who dropped out of the labor force over that same period. (The numbers don’t quite add up because the age group data are not seasonally adjusted as are the aggregate data.)

By the way, the Monetary Policy Report submitted by the Fed to Congress noted that while there might be structural explanations for the falling participation rate related to the aging of the Baby Boomers, the employment-to-population ratio remains very depressed. This suggests that “some of the weakness in participation is also likely due to workers’ perceptions of relatively poor job opportunities.”

What other labor market indicators are Yellen and her colleagues monitoring? According to their report, “For example, the share of the unemployed who have been out of work longer than six months and the percentage of the workforce that is working part time but would like to work full time have declined only modestly over the recovery.” Yellen & Co. are also watching the quit rate--“an indicator of workers’ confidence in the availability of other jobs”--which remains low.

(Based on an excerpt from YRI Morning Briefing)

Fed Chair Janet Yellen presented the Fed’s semiannual Monetary Policy Report to a congressional committee in the House on Tuesday, February 11. She was scheduled to do so again before a Senate committee the next day, but the session was postponed until Thursday, February 27 because of a snowstorm. Previously, on several occasions, I’ve described Yellen as the “Fairy Godmother of the Bull Market.” The stock market has tended to move higher in reaction to her comments on monetary policy ever since she joined the Fed’s Board of Governors during October 2010.

She did it again last month. The S&P 500 is up 3.3% since the day before she spoke on February 11. It rose to a new record high by last Thursday’s close, and still higher on Friday to 1859.45, up 0.6% ytd and 6.7% from the February 3 low. It is only 8.3% below our yearend target of 2014.

In her past comments, Yellen often either signaled a continuation of ultra-easy monetary policy at the next FOMC meeting or confirmed that such decisions were made at the previous meeting. This partly explains why stock prices have tended to rise so often both before and after FOMC meetings since Fed Governor Yellen started sprinkling her fairy dust.

In her identical prepared remarks for both congressional committees last month, Yellen emphasized that the Fed’s monetary policy would remain on the same course as it had been under Ben Bernanke: “Turning to monetary policy, let me emphasize that I expect a great deal of continuity in the FOMC's approach to monetary policy. I served on the Committee as we formulated our current policy strategy and I strongly support that strategy, which is designed to fulfill the Federal Reserve's statutory mandate of maximum employment and price stability.”

Under Yellen, the Fed’s number one priority will continue to be to avoid another Lehman-style meltdown and a depression. The second priority remains to revive the labor market. If so, then the “scary parallel” chart showing an amazing correlation between the DJIA from 2013-2014 and 1928-1929 isn’t likely to be a useful paradigm, as I’ve argued before.

The chart went viral over the Internet in late January and early February, heightening fears of an imminent crash. The relationship has started to diverge in recent days, with the DJIA moving higher rather than crashing thanks in part to Yellen’s comforting testimony. Of course, concerns about the Ukrainian crisis could send stock prices down again over the next few days, though I doubt that it could somehow cause a recession in the US and end the bull market.

By the way, bearishly inclined technicians also saw some correlation between the current bull market since 2009 and the previous one from 2003-2007. That paradigm stopped working last year as the S&P 500 rose into record territory contrary to the bearish script of 2007. A closer fit can be found between the DJIA from 2006-2008 and 1928-1930, though the magnitude of the most recent crash wasn’t as bad as the Great Crash.

(Based on an excerpt from YRI Morning Briefing)

The message to emerging economies in today’s FOMC statement was: “Vaya con Dios.” Of course, that phrase did not appear in the statement. Rather, it was implied when the recent crisis among several emerging economies wasn’t mentioned at all. In other words: “We wish you well, but your problems aren’t our problem. So there’s no reason to suggest that your crisis is having any impact on US monetary policy.”

Indeed, Fed officials seem quite sanguine that the crisis among some of the emerging economies won’t have any significant impact on the US economy. On the contrary, the FOMC statement noted: “The Committee expects that, with appropriate policy accommodation, economic activity will expand at a moderate pace and the unemployment rate will gradually decline toward levels the Committee judges consistent with its dual mandate. The Committee sees the risks to the outlook for the economy and the labor market as having become more nearly balanced.” The exact same comments appeared in the previous statement following the 12/18 meeting of the FOMC. I agree with the Fed's assessment.

As was widely expected, the FOMC voted to taper QE by another $10 billion to $65 billion per month. There were no dissenters. So the committee unanimously voted to reject the recent advice of IMF officials and economists to temper their tapering for the sake of the emerging economies.

How will the Fed respond to last week’s global financial turmoil? The FOMC meets this week on Tuesday and Wednesday. It is widely expected that the committee will continue to taper QE. They started to do so after the previous meeting on December 18, when the FOMC statement noted that “the Committee will likely reduce the pace of asset purchases in further measured steps at future meetings.” Bond purchases were reduced from $85 billion per month to $75 billion per month.

According to a 1/20 WSJ article by Jon Hilsenrath, despite December’s weak employment report, the Fed is on track to taper QE to $65 billion at the FOMC meeting this week. In his Barron’s column this week, Randy Forsyth explains why he thinks the Fed will do so, notwithstanding last week’s global financial instability:

Speculation in the markets Friday suggested that the FOMC wouldn't taper in view of the market turmoil. That seems highly unlikely on two counts: First, the FOMC only made the first, small reduction in its so-called quantitative easing…at its December meeting. The S&P 500 is down all of 3.3% from its record hit in mid-January. That's a reason to change course so soon? To do so would suggest panic. Moreover, the Treasury market already has eased in reaction to the turmoil. The benchmark 10-year note's yield is down about 30 basis points…to 2.72% since the turn of the year--when the universal forecast was that yields had nowhere to go but up.

I tend to agree with Randy. Last week’s turmoil might make Fed officials realize that their ultra-easy monetary policy has inflated yet another speculative bubble, this time in emerging markets. Taking the air out of it might be wiser than continuing to inflate it.

If this bubble is about to burst, then once again Fed officials didn’t see it coming. They’ve been aware of the possibility, but minimized its likelihood. Obviously, they once again failed to learn from history, which shows that excessively easy credit conditions tend to inflate speculative bubbles that inevitably burst. Let’s review what Fed officials said (or did not say) on this subject:

(1) FRB Governor Jeremy Stein. In a speech on February 7, 2013, Governor Jeremy Stein discussed several areas in which a noticeable increase in risk-taking behavior had emerged. He did not mention emerging economies. Rather, he focused on risks in the corporate bond market, but was reassuringly unconcerned about the potential adverse consequences for the financial system.

(2) FRB Vice Chair Janet Yellen. On April 16, 2013, Fed Vice Chair Janet Yellen spoke at a conference on monetary policy sponsored by the IMF. In her remarks, she briefly speculated about speculation, but concluded that there is nothing to worry about: “I don’t see pervasive evidence of rapid credit growth, a marked buildup in leverage, or significant asset bubbles that would threaten financial stability. But there are signs that some parties are reaching for yield, and the Federal Reserve continues to carefully monitor this situation.”

(3) Fed Chairman Ben Bernanke. In his press conference on September 18, 2013, Fed Chairman Ben Bernanke was asked for his reaction to charges coming out of emerging economies that the Fed’s policies have been causing them financial distress. His initial response was that “we’re watching that very carefully.” Then, he went on to defend the Fed’s policies as good for everyone:

The main point, I guess, I would end with, though, is that what we’re trying to do with our monetary policy here is, I think, my colleagues in the emerging markets recognize, is trying to create a stronger US economy. And a stronger US economy is one of the most important things that could happen to help the economies of emerging markets.

(Based on an excerpt from YRI Morning Briefing)

Could it be that the Fed’s ultra-easy monetary policy has already inflated yet another speculative bubble that is about to burst, or at least lose lots of air very quickly? If so, the obvious candidate is emerging economies, which borrowed lots of money (often in dollars) in recent years. They were able easily to attract foreign buyers, who were “reaching for yield” because interest rates were so low in the bond markets of the US, Europe, and Japan. The capital inflows boosted their currencies. That may have started to reverse during the spring and summer of 2013, when Fed officials began to talk about tapering QE, which boosted bond yields in the US and around the world, especially in the emerging economies.

If this bubble is about to burst, then once again Fed officials didn’t see it coming. They’ve been aware of the possibility, but minimized its likelihood. Obviously, they once again are failing to learn from history, which shows that easy credit conditions always lead to speculative bubbles that inevitably burst. Let’s review what Fed officials said (or did not say) on this subject:

1) FRB Vice Chair Janet Yellen. On April 16, 2013, Fed Vice Chair Janet Yellen spoke at a conference on monetary policy sponsored by the IMF. In her remarks, she briefly speculated about speculation, but concluded that there is nothing to worry about:

Some have asked whether the extraordinary accommodation being provided in response to the financial crisis may itself tend to generate new financial stability risks. This is a very important question. To put it in context, let’s remember that the Federal Reserve’s policies are intended to promote a return to prudent risk-taking, reflecting a normalization of credit markets that is essential to a healthy economy. Obviously, risk-taking can go too far. Low interest rates may induce investors to take on too much leverage and reach too aggressively for yield. I don’t see pervasive evidence of rapid credit growth, a marked buildup in leverage, or significant asset bubbles that would threaten financial stability. But there are signs that some parties are reaching for yield, and the Federal Reserve continues to carefully monitor this situation.

On March 4, in a speech titled, “Challenges Confronting Monetary Policy,” Yellen said that the Fed is watching out for risks in the financial system and that so far there is nothing to worry about:

At this stage, there are some signs that investors are reaching for yield, but I do not now see pervasive evidence of trends such as rapid credit growth, a marked buildup in leverage, or significant asset bubbles that would clearly threaten financial stability. That said, such trends need to be carefully monitored and addressed, and the Federal Reserve has invested considerable resources to establish new surveillance programs to assess risks in the financial system. In the aftermath of the crisis, regulators here and around the world are also implementing. a broad range of reforms to mitigate systemic risk. With respect to the large financial institutions that it supervises, the Federal Reserve is using a variety of supervisory tools to assess their exposure to, and proper management of, interest rate risk.

On January 4, 2013, Yellen spoke at a joint lunch of the American Economic Association / American Finance Association in San Diego. The word “risk” appears 82 times in her speech titled, “Interconnectedness and Systemic Risk: Lessons from the Financial Crisis and Policy Implications.” Her presentation was a general overview, without getting into any specifics. The risk of a bubble in emerging economies was not mentioned.

2) FRB Governor Jeremy Stein. In her March 4 speech, Yellen noted in a footnote that her colleague, Governor Jeremy Stein, had given a speech on February 7, 2013 in which he “discussed several areas in which a noticeable increase in risk-taking behavior has emerged.” He did not mention emerging economies. Rather, he focused on risks in the corporate bond market, but was reassuringly unconcerned about the potential adverse consequences for the financial system:

Putting it all together, my reading of the evidence is that we are seeing a fairly significant pattern of reaching-for-yield behavior emerging in corporate credit. However, even if this conjecture is correct, and even if it does not bode well for the expected returns to junk bond and leveraged-loan investors, it need not follow that this risk-taking has ominous systemic implications. That is, even if at some point junk bond investors suffer losses, without spillovers to other parts of the system, these losses may be confined and therefore less of a policy concern.

3) Fed Chairman Ben Bernanke. In his press conference on September 18, 2013, Fed Chairman Ben Bernanke was asked for his reaction to charges coming out of emerging economies that the Fed’s policies have been causing them financial distress. His initial response was that “we’re watching that very carefully.” Then, he went on to defend the Fed’s policies as good for everyone:

The main point, I guess, I would end with, though, is that what we’re trying to do with our monetary policy here is, I think, my colleagues in the emerging markets recognize, is trying to create a stronger U.S. economy. And a stronger U.S. economy is one of the most important things that could happen to help the economies of emerging markets. And, again, I think my colleagues in many of the emerging markets appreciate that--notwithstanding some of the effects that they may have felt--that efforts to strengthen the U.S. economy and other advanced economies in Europe and elsewhere ultimately redounds to the benefit of the global economy, including emerging markets as well.

How will the Fed react to today’s weak payroll employment report? When the FOMC meets on January 28-29, odds are that the committee will vote to maintain the current pace of bond purchases at $75 billion, which was lowered from $85 billion at the previous meeting on December 17-18. They might have considered tapering some more if the report had been as strong as suggested by December’s ADP private payrolls survey. Now that’s less likely.

At the previous meeting, there seemed to be a difference of opinion between the members of the FOMC and the Fed’s staff on the outlook for the economy. The former were more optimistic than the latter. Indeed, according to the minutes of that meeting, the staff viewed the risks to the forecast for real GDP growth “as tilted to the downside, reflecting concerns that the extent of supply-side damage to the economy since the recession could prove greater than assumed; that the tightening in mortgage rates since last spring could exert greater restraint on the housing recovery than had been projected; that economic and financial stresses in emerging market economies and the euro area could intensify; and that, with the target federal funds rate already near its lower bound, the U.S. economy was not well positioned to weather future adverse shocks.” Recent better-than-expected economic indicators suggested that the staff was too pessimistic, but the payroll report is more consistent with their view.

The minutes also noted that further reductions in bond purchases “would be undertaken in measured steps.” That was widely viewed as implying that the Fed might taper QE by $10 billion per meeting if the economic data remained strong. In his WSJ article on the Fed’s likely reaction to the employment data, Jon Hilsenrath concluded: “Friday’s report should put to rest for the time being any notion that the Fed will reduce the bond-buying program more quickly than planned.”

The FOMC is composed of the seven members of the Board of Governors and five Reserve Bank presidents. The president of the Federal Reserve Bank of New York serves on a continuous basis; the presidents of the other Reserve Banks serve one-year terms on a rotating basis. This year, the voting presidents will be Sandra Pianalto (Cleveland), Charles Plosser (Philadelphia), Richard Fisher (Dallas), and Narayana Kocherlakota (Minneapolis). On Friday, President Barack Obama nominated Stanley Fischer as the Fed’s next vice chairman and Lael Brainard as a governor. He also nominated Governor Jerome Powell to another term.

My assessment is that not much will change under incoming Fed Chair Janet Yellen. The doves will continue to determine the course of monetary policy. However, tapering should continue, with the termination of QE likely by the end of the year. Stanley Fischer is likely to be a more pragmatic and less liberal vice chair than was Ms. Yellen. He has expressed some skepticism about providing forward guidance. However, he is likely to be a team player.

The question is whether QE5--i.e., the tapering of QE4--will cause another significant correction or even kill the bull if tapering leads to the termination of quantitative easing. Yesterday’s minor 0.4% drop in the S&P 500 suggests that stock investors might be ready to tolerate more tapering, which was implied in the minutes released yesterday of the December 17-18 FOMC meeting. Consider the following:

(1) More discussion of financial risks. The latest minutes accentuated the risks of financial instability caused by ultra-easy monetary policy much more so than any previous ones since the start of the bull market. Previous ones, especially those that discussed and justified the implementation of the various QE policies, stressed the importance of doing so to restore financial stability. The pendulum is starting to swing the other way.

The minutes noted: “In their discussion of potential risks, several participants commented on the rise in forward price-to-earnings ratios for some small-cap stocks, the increased level of equity repurchases, or the rise in margin credit. One pointed to the increase in issuance of leveraged loans this year and the apparent decline in the average quality of such loans.”

(2) Financial instability and QE. Perhaps the oddest part of the minutes was a discussion of a survey conducted by the Fed’s staff “over the intermeeting period regarding participants’ views of the marginal costs and marginal efficacy of asset purchases.” I don’t recall anything like this before. Aren’t they all supposed to be sharing their views during the actual meetings?

In any event, once again, the risks of financial instability were raised in this discussion of the survey: “Participants were most concerned about the marginal cost of additional asset purchases arising from risks to financial stability, pointing out that a highly accommodative stance of monetary policy could provide an incentive for excessive risk-taking in the financial sector. It was noted that the risks to financial stability could be somewhat larger in the case of asset purchases than in the case of interest rate policy because purchases work in part by affecting term premiums and policymakers have less experience with term premium effects than with more conventional interest rate policy.”

(3) Diminishing returns. The survey also found that participants are mostly curbing their enthusiasm for QE: “A majority of participants judged that the marginal efficacy of purchases was likely declining as purchases continue, although some noted the difficulty inherent in making such an assessment.”

In other words, they think it worked, but they aren’t sure it is working as well anymore, and aren’t sure how to know or measure any of that! So maybe phasing it out is a good idea. Not so fast: “Most participants judged the marginal costs of asset purchases as unlikely to be sufficient, relative to their marginal benefits, to justify ending the purchases now or relatively soon.” But they don’t know that for sure.

(4) Complicating the exit strategy. Here’s another good reason to phase out QE, according to the survey discussed in the minutes: “Further, participants noted that ongoing asset purchases could increase the difficulty of managing exit from the current highly accommodative policy stance when the time came. Many participants, however, expressed confidence in the tools at the Federal Reserve's disposal for managing its balance sheet and for normalizing the stance of policy at the appropriate time.”

(5) Capital losses. Another interesting point raised in the survey is that the bigger the Fed’s balance sheet, the greater the losses will be when interest rates move higher. They are already doing so in the bond market. Not to worry: “Participants also expressed some concern that additional asset purchases increase the likelihood that the Federal Reserve might at some point suffer capital losses. But it was pointed out that the Federal Reserve's asset purchases would almost certainly provide significant net income to the Treasury over the life of the program, especially when the effects of the program on the broader economy were taken into account, and that potential reputational risks to the Federal Reserve arising from any future capital losses could be mitigated by communicating that point to the public.”

(Based on an excerpt from YRI Morning Briefing)

The minutes of the FOMC meeting held on December 17 and 18 was released today. Here are some of the key points regarding the risks that QE could increase financial instability:

(1) More discussion of financial risks. The latest minutes accentuated the risks of financial instability caused by ultra-easy monetary policy much more so than any previous ones since the start of the bull market. Previous ones, especially those that discussed and justified the implementation of the various QE policies, stressed the importance of doing so to restore financial stability. The pendulum is starting to swing the other way.

The minutes noted: “In their discussion of potential risks, several participants commented on the rise in forward price-to-earnings ratios for some small-cap stocks, the increased level of equity repurchases, or the rise in margin credit. One pointed to the increase in issuance of leveraged loans this year and the apparent decline in the average quality of such loans.”

(2) Financial instability and QE. Perhaps the oddest part of the minutes was a discussion of a survey conducted by the Fed’s staff “over the intermeeting period regarding participants’ views of the marginal costs and marginal efficacy of asset purchases.” I don’t recall anything like this before. Aren’t they all supposed to be sharing their views during the actual meetings?

In any event, once again, the risks of financial instability were raised in this discussion of the survey: “Participants were most concerned about the marginal cost of additional asset purchases arising from risks to financial stability, pointing out that a highly accommodative stance of monetary policy could provide an incentive for excessive risk-taking in the financial sector. It was noted that the risks to financial stability could be somewhat larger in the case of asset purchases than in the case of interest rate policy because purchases work in part by affecting term premiums and policymakers have less experience with term premium effects than with more conventional interest rate policy.”

(3) Diminishing returns. The survey also found that participants are mostly curbing their enthusiasm for QE: “A majority of participants judged that the marginal efficacy of purchases was likely declining as purchases continue, although some noted the difficulty inherent in making such an assessment.”

In other words, they think it worked, but they aren’t sure it is working as well anymore, and aren’t sure how to know or measure any of that! So maybe phasing it out is a good idea. Not so fast: “Most participants judged the marginal costs of asset purchases as unlikely to be sufficient, relative to their marginal benefits, to justify ending the purchases now or relatively soon.” But they don’t know that for sure.

(4) Complicating the exit strategy. Here’s another good reason to phase out QE, according to the survey discussed in the minutes: “Further, participants noted that ongoing asset purchases could increase the difficulty of managing exit from the current highly accommodative policy stance when the time came. Many participants, however, expressed confidence in the tools at the Federal Reserve's disposal for managing its balance sheet and for normalizing the stance of policy at the appropriate time.”

(5) Capital losses. Another interesting point raised in the survey is that the bigger the Fed’s balance sheet, the greater the losses will be when interest rates move higher. They are already doing so in the bond market. Not to worry: “Participants also expressed some concern that additional asset purchases increase the likelihood that the Federal Reserve might at some point suffer capital losses. But it was pointed out that the Federal Reserve's asset purchases would almost certainly provide significant net income to the Treasury over the life of the program, especially when the effects of the program on the broader economy were taken into account, and that potential reputational risks to the Federal Reserve arising from any future capital losses could be mitigated by communicating that point to the public.”