According to Eric Lascelles, chief economist at RBC Global Asset Management, the Federal Reserve's most recent quantitative easing program - dubbed QE2 - has been a "grand success." By printing money to buy U.S. Treasury bonds, the Fed has effectively boosted consumer confidence, equities and commodities.
But with QE2 expected to wind down in June, and with no replacement in the works, some investors are concerned about whether the end of this experimental stimulus will unravel this success. After all, it was the anticipation of quantitative easing that roused stock markets from last summer's doldrums. Mr. Lascelles argues that the fear is overdone.
First of all, he has considerable faith in the efficiency of markets, noting that asset prices should already be budgeting for the end of stimulus. This partly explains why stock market indexes are off their highs - though Mr. Lascelles acknowledges that the European debt crisis and some disappointing economic indicators are also playing a role.
He has four other reasons to stay calm:
- "The Fed is cognizant of the effect that its stimulus program has had on risk assets, and is loath to act in a manner that would see those gains lost."
- "The boost from monetary stimulus does not decline after June; it only stops growing."
- "History tells us that the end to quantitative easing, and, for that matter, the start of monetary tightening is not usually bad for markets."
- "Despite the imminent loss of a major source of demand for U.S. Treasuries, supply/demand considerations usually take a back seat to other market drivers."
As for what happens to markets when QE2 ends, he believes that bond yields should rise over time (as bond prices fall) as markets begin to anticipate Fed rate hikes and rising inflation expectations. For stocks, the recent pace of price gains should moderate as economic indicators peak. And the U.S. dollar should strengthen against other currencies.
David Berman