The End Of QE2 – Should We Worry?
The Dynamic Wealth Report
March 3, 2011
by Jay Chernoff, Editor
Earlier this week, I happened to glance over at the calendar sitting on
my desk. I often lose track of the days… it’s a common malady among
writers. So imagine my surprise when I saw what month it was.
It’s March already? When did that happen?
Ah March… Springtime… The NCAA Basketball Tournament… Spring Training!
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And of course, we’re just three months away from the end of QE2.
We’ve grown used to the idea of quantitative easing by now. The Fed’s
just been there in the background, quietly pumping billions of dollars
into the economy. It’s been a comforting backdrop for months now, like
an old sweater in our closet… it’s there when we need it.
But just as the weather heats up in June, the economy may be seeing a
burst of frigid headwinds. And this time we won’t have that old sweater
to keep us warm.
Should we be worried?
Bill Gross of PIMCO thinks so.
In case you don’t know, Bill Gross is the co-founder of PIMCO, one of
the largest investment management companies in the world. Gross is often
in the news discussing his views on the economy.
So here’s what Gross says about the end of QE2…
“Because QE has affected not only interest rates but stock prices and
all risk spreads, the withdrawal of nearly $1.5 trillion in annualized
check writing may have dramatic consequences in the reverse direction."
In other words, he thinks pulling the plug on QE2 could plunge the
economy back into a recession.
Here’s more…
“What I would point out is that Treasury yields are perhaps 150 basis
points or 1½% too low when viewed on a historical context.”
So, Gross feels we’ll see a 1.5% jump in interest rates after QE2 ends.
And finally…
“By eliminating QE II, the Fed would be ripping a Band-Aid off a
partially healed scab. Ouch!”
That one’s pretty self explanatory. Clearly, Gross is worried about the
Fed shutting down QE2. He seems to think it could have disastrous
effects on the economy. And his main concern appears to be higher
interest rates.
Should we be concerned about these comments from Gross? Is the end of
QE2 in June going to mean another recession?
I don’t think so.
Keep in mind, Gross and PIMCO have a major stake in quantitative easing. PIMCO runs the world’s largest bond fund, with over $240 billion in
assets.
And, bonds are at record high levels these days.
Low interest rates mean higher bond prices… and that’s great for PIMCO’s
massive bond portfolio. As soon as rates start rising, those bond prices
are going to drop. Certainly, PIMCO isn’t thrilled about the prospects
of higher rates.
Let me put it this way… Gross’ comments are purely self-serving.
They want to keep the money train running over at PIMCO. The end of QE2
could mean higher interest rates – and inflation – are on the way. And
Gross wants to delay that day as long as possible.
Personally, I think his self-serving views are missing a major point.
Long-term inflation simply isn’t a concern right now.
Yes, we’re seeing some commodity inflation right now. As I’m sure you’ve
seen, crude oil topped $100 a barrel recently. But, I think it’s just
temporary.
Many commodity prices are being driven higher by the crisis in the
Middle East. Once the turmoil settles down, the fear premium built into
commodities should also diminish.
What’s more, there’s no evidence higher commodity prices are leading to
higher long-term inflation.
Fed chairman Ben Bernanke agrees. In his testimony to Congress this
week, he addresses this very issue. Bernanke believes commodity price
inflation is a short-term situation. And he doesn’t see inflation
ramping up until 2013.
But you don’t need to ask Bernanke or anyone else… just look at the
ultimate judge of inflation expectations… bond prices themselves. And it
appears the bond markets agree with Bernanke, not Gross. Bonds are
pricing in very reasonable long-term inflation.
Here’s the bottom line…
When QE2 ends, we might miss it. It’s been quite the comfort for us
during a difficult economic period. Hey, throwing away that old sweater
is never easy… but eventually it’s time to move on.
And frankly, the end of QE2 isn’t likely to send our economy back into
recession.
Bill Gross may be concerned about the economy, but I’ll bet he’s more
worried about his $240 billion bond portfolio. If I were you, I wouldn’t
lose sleep about the end of QE2. When June rolls around, the only thing
you should be concerned about is where the closest poolside is.
One of the biggest gainers in the ETF/ETN world this week is iPath
DJ-UBS Cotton Index ETN (BAL). It’s up almost 6% today and a whopping
143% over the last 52 weeks. BAL tracks the performance of cotton by
using futures. Cotton is screaming higher on increasing demand and
diminishing supplies.
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