Fed’s Monetary Policy Losing SteamThis won’t be the first time I’ve stated my opinion that the current Federal Reserve monetary policy is not only becoming greatly ineffective, but also dangerous to your investments.

And now, there are growing voices joining this cautious call. The surprising fact is that even the members of the Federal Reserve are now voicing concerns of the dangers inherent in the central bank’s current monetary policy program.

Charles Plosser, the current Federal Reserve Bank of Philadelphia President, stated in a speech that the Federal Reserve’s asset repurchase program needs to be reduced and eliminated by the end of 2013. His reasoning, like mine, is that the costs outweigh the benefits.

The most interesting statement by Fed President Plosser was, “…monetary policy is posing risks to the economy in terms of financial stability, market functioning and price stability.” (Source: Kearns, J. and Gage, C.S., “Plosser says Fed should taper QE as costs exceed benefits,” Bloomberg, March 6, 2013.)

When I think of the massive amount of money that the Federal Reserve has pumped into the U.S. economy, it is shocking that the Federal Reserve’s balance sheet is in excess of $3.0 trillion and yet the U.S. economy grew just 0.1% in the fourth quarter of 2012.

While cuts in the defense budget certainly explain a huge portion of the weak quarter, it is clear that the monetary policy program by the Federal Reserve has become ineffective. While there may be marginal improvements in certain sectors, the costs that I’ve been discussing previously, and which Plosser is now elucidating, will be very severe.

The scariest part of the Federal Reserve’s monetary policy program is the fact that it’s unprecedented. No one can predict exactly what will happen. Imagine building up a balance sheet of over $3.0 trillion and not knowing how to get out.

Even Plosser stated that he doesn’t know if the Federal Reserve can simply hold onto these assets until maturity or even sell them into the market.

I think it’s quite shocking that a central bank can build up such a huge amount of assets without first having an exit strategy.

Which investments will be hurt by the withdrawal of monetary policy?

Look to the investments that have gone upward in value. Stocks and bonds have had a tremendous run over the past couple of years. The monetary policy program by the Federal Reserve created a huge amount of money, which was funneled into the stock and bond markets.

Once the Federal Reserve begins to reduce monetary policy, it will have a dramatic effect on stocks and bonds. If much of the move upward has been fueled by stimulus generated by the Federal Reserve, it stands to reason that these investments will fall once the monetary stimulus has ended.

While the U.S. economy is not growing very quickly, its stability is still allowing some jobs growth. If the mild pace of jobs growth continues, the market will begin to anticipate a reduction in monetary policy by the Federal Reserve this fall.

Once those discussions begin amongst investment managers, I would expect a dramatic decline in both the stock and bond markets. Historically, September and October have been dangerous months, and the timing could coincide with discussion by the Federal Reserve of producing monetary policy stimulus. In my opinion, this will be extremely hazardous to both stocks and bonds. After all, once the air begins to leak out of a balloon, there’s not much left to keep it afloat.