Is the Fed Making a Big Mistake?

It’s the decision that everyone has been talking about. (No, this ain’t about Kanye and Kim naming their kid “North” West.) In the most recent FOMC rate decision, the Fed finally confirmed market speculation that the central bank could soon scale back on its asset purchases.

In case you’ve forgotten, Fed Reserve Chairman Ben Bernanke announced that the Fed could reduce its asset purchases, which currently stands at $85 billion a month, later this year. He even said that they could end QE3 by mid-2014.

Consequently, this has led to a massive dollar rally. Looking at the USDX chart, it seems like there still aren’t any signs of it slowing down!

USDX Chart

But some market junkies are skeptical about the Fed’s decision. Could they be making a mistake?

Going back to the last FOMC statement, policymakers expressed their optimism for the job market. They even said that they might be able to hit their 6.5% unemployment rate target by next year.

However, a closer look at the labor market leaves much to be desired. A lot of the improvements we’ve been recently seeing are only due to the pick-up in part-time and lower-wage-paying jobs. In other words, the quality of job growth isn’t very impressive since we’re not seeing gains in full-time positions.

It’s also noteworthy to point out that the labor pool has been shrinking. This actually accounts for a big chunk of the continued drop in the unemployment rate. That being said, it may not be a very wise idea to take celebrate the unemployment rate at face value.

As for its growth outlook, the Fed does have a history of looking at things through rose-tinted glasses. It has been overly optimistic over the past three years, and as a result, the central bank has made a number of overstated growth forecasts.

For instance, at the start of 2011, it had predicted a growth of 3.95% for 2012. However, we know that real GDP during that year only clocked in at 2.2%. Similarly, it had estimated a growth of about 4% for 2013. Yet here we are today, on track to see the economy expand by just 2.3%.

Let’s face it, the Fed’s economic forecasts haven’t exactly been the most reliable. Yes, the central bank may have some of the greatest minds and tons of information to work with, but at the end of the day, their forecasts are still just educated estimates.

And lest we forget, the U.S. economy still faces some challenges that present considerable threats to growth. The government’s budget cuts, recent tax hikes, and weak global demand present major drags in the economy.

At the end of the day, I think what we have to keep in mind is that the Fed is still only considering cutting back its asset purchases. By no means is this set in stone.

Remember that the Fed ultimately bases its decisions on economic performance. So if economic data in the following months come out very weak and suggest a need for more QE, the Fed may just have to reconsider its stance.