Analysts fear that in 2014, the US Fed’s QE “tapering” will lead to volatility in US markets too in just the same that it has spooked those in emerging market economies, says Mary Caplinger
17th February 2014
With central banks manipulating interest rates and money supply across the world, do we still have a “free market system”? Many US economists and analysts feel the answer is a big “No” and in their view the easy money policy of central banks that has created an artificial economic environment without true market rates is a perfect recipe for big trouble ahead.
The US Federal Reserve Bank’s stimulus policy to tackle the after effects of the Global Financial Crisis (GFC) of 2008 has seen basic interest rates being held at a near zero level and trillions of dollars pumped into the global financial system to boost, or at least sustain, assets around the globe. Every financial market on the planet has been influenced.
Many analysts believe the policy of infusing the system with massive amounts of fresh liquidity has created a “bubble” that now risks bursting with the Fed slowing down the flow of this easy money. This risk is best exemplified by the fact that ever since the Fed announced in June, 2013 that it would end its QE programme, markets around the world have reacted sharply forcing the US central bank to set forth a policy of “tapering” or gradually unwinding its stimulus. Even then, any mention of the “t” word has seen markets begin to convulse.
For example, when the Fed announced on December 18, 2003 its plan to cut its monthly purchases of Treasury and mortgage-backed securities from $85 billion to nothing by the end of 2014 in a series of small steps, starting with a reduction to $75 billion in January, the market responded with a beautiful 200-point rally.
“A major reason for investor enthusiasm is that the stimulus will be withdrawn very gradually,” Michael Hanson, senior economist at Bank of America Merrill Lynch, had explained. Sadly, however, the next day the market sold off, and global equity markets have been on a wild ride since then with market pros expecting such volatility to continue.
“Some of the most savvy analysts, technicians and traders look for 2014 to be a year of more than mere volatility. They see a real downside correction for the markets following the gradual and necessary cessation of the Quantitative Easing Programs that have been in effect these past years since QE has been the major driver for the market to rise to new levels. The global markets are already showing this as the markets are all so intertwined. Both failures and successes are infectious – and “bubbles” are not so easily managed,” Mary Holloway Love, analyst and former full service broker at Dallas Securities Investment Corp. told IFM.
Other analysts are even more pessimistic. “I just think you’re going to have a very severe, very substantive and really quite ugly correction that will probably make a lot of people wail and gnash their teeth before it’s done” wrote Dennis Gartman, editor and publisher of The Gartman Letter on Monday last week. Doug Short, vice president of research at Advisor Perspectives, echoed similar views when he said the U.S. stock market “still looks 67% overvalued”.
Controversial economist, author and commentator Peter Schiff, one of those who had predicted the crisis of 2008, has for long been a strong critic of American economic policies. As recently as November, 2013, while speaking at the New Orleans Investment Conference, he predicted that the price of gold would skyrocket in 2014 when all global currencies would stand devalued by 50 percent.
His views are shared by Brien Lundin, editor and publisher of Gold Newsletter. “Gold boasts a millennia-old track record as the only protection against the inevitable corruption of currencies. And thus, there has developed an inverse relationship between fiat currencies and the price of gold. Simply put, the more dollars, Euros, yen and other fiat currencies are created, the greater the relative worth of gold,” he wrote by way of criticising the Fed’s easy money policy.
No wonder that the Fed now finds itself in a “catch 22” position when it comes to stimulus – damned if it continues with it and damned if it doesn’t. If it continues with QE indefinitely, it could cause serious economic damage as some economists warn. If it cuts QE, the market will protest mightily. The Fed is stuck! And it seems the only way out will cause big time pain.
That’s what the talk of “$10 billion taper” did and 10-year rates doubled from 1.5% to 3%. America is an interest rate sensitive economy. Housing, auto, corporations, local/muni/federal all are dependent on the Fed’s QE to continue and even further lower interest costs. The Federal Reserve is boxed in, in that it cannot slow QE due to negative interest rate impact – and the equity market knows this. Many believe that if the Fed stopped QE entirely, the results for the system would be akin to a junkie a fix and going cold turkey.
A foreboding example of what could lie ahead for the US can be seen in Japan. Both of these countries have been and are engaged in significant monetary easing and both countries have seen a boom in equity markets, however dampened in 2014. Japan’s growth is at best, lackluster and certainly behind that of the US, but their perpetual stagnation serves as a warning. As long as the Federal Reserve’s zero interest rate policy stays in place, the more difficult it will be to get out of the resulting liquidity trap and restore a more normal flow of financial intermediation within the US. Many believe that such restoration is sorely needed to avoid the stagnation we are seeing in Japan.
Some economists advise that new Fed chair Janet Yellen should do a “Bubble Test” and stop QE altogether for a month or two. If nothing happens then there is no anticipated bubble. If the markets crash then one is confirmed. Most people know that the Fed is manipulating interest rates; and many believe that any time you create an artificial environment – without true market rates – you are asking for big trouble down the road. They refer to recent historical bubbles – the Internet, dot coms, housing. No one knew there was a bubble till it burst. “Those that don’t learn from history are doomed to repeat it” as the saying goes. And this year, the repetition of history could go from London, to New York, to Frankfurt, to Paris, nay, all across the world.