Announcing another $10 billion reduction in the Federal Reserve Board’s bond-buying programs known as QE3, Chairman Ben S. Beranke went quietly into the night handing the baton to 67-year-old Janet Yellen. Complaining about the Fed’s stimulus programs since markets crashed in 2008, conservatives got a rude awakening watching markets drop another one percent. When former President George W. Bush bailed out banks to the tune of $700 billion Oct. 3, 2008, conservatives didn’t say a boo until President Barack Obama followed suit with a second bailout of $690 billion March 20, 2009 designed to re-supply banks with cash after the derivatives market collapsed leaving mortgage-backed securities worthless. Republicans only complained once Barack took over Jan. 20, 2009, insisting the Fed’s quantitative easing strategy would eventually wreck the U.S. economy.
Getting what they’ve asked for, Bernanke left office trimming another $10 billion off QE3, citing an improving U.S. unemployment now at 6.7%. Wall Street doesn’t need much to switch gears from going long to short, letting short-selling hedge and private equity funds dominate the market. Over the last five trading sessions, Wall Street has lost over 5% with more selling on the way. “Economic activity picked up in recent quarters,” said Beranke, justifying his move to reduce treasury purchases. If Yellen continues to reduce QE3, there’s no telling how low markets could go. When market unraveled in 2007-08, it didn’t take long for the Dow’s Oct. 9, 2007 record of 14,164 to vaporize March 9, 2009 to 6,547 or a 54% drop, wiping out $7 trillion in personal and corporate wealth. Wells Fargo’s bearish chief equities strategist Gina Martin Adams sees Walls Street dropping 50%.
Yale economics professor and 2013 Nobel winner Robert Shiller sees Wall Street nearing a bubble, suggesting that underlying asset values don’t match today’s inflated share prices. Shiller’s cyclically-adjusted price-to-earnings ratio suggests that current prices are unsustainable without a sizable market correction. Once hedge and private equity funds decide to go short, it could trigger market slide that could fulfill Martin-Adams and Shiller’s predictions. With the bond market rallying, dropping the 10-year Treasury dropping to 2.59%, it shows a flight out of equities for nervous hedge and private equity funds. “The Fed’s action today represents a continuation of its resolute determination to end [bond purchases] during 2014,” said Daniel Alpert, managing partner of New York-based Westwood Capital. “The policy has hit its ‘sell by’ date,” hinting at more selling.
Reducing QE3 was bound to discount equities and rally the bond market. How far equities have to slide before they’re once again attractive to major funds isn’t easy to answer. While the Fed looks at the Labor Dept.’s unemployment rate, Yellen will re-evaluate QE3 at February’s Open Market Committee meeting. If Wall Street continues to unravel, it’s possible Yellen would halt further reductions in QE3 or possibly increase bond purchases. With Wall Street trimming stock portfolios, it’s possible companies could slow down on hiring practices, potentially ratcheting up the unemployment rate. Reducing its bond purchases by $20 billion could create a new liquidity crisis for banks, looking to sell mortgage-backed securities. If banks have less cash, it likely they’ll lend out less money on real estate and commericial purchases further depressing U.S. Gross Domestic Product.
Touting U.S. economic growth in last night’s State of the Union Speech, President Barack Obama can’t rest on his laurels with Midterm election around the corner. While there’s been much progress adding 8 million jobs since March 2010, things could crash quickly. Today’s economy, that led to a 6.7% unemployment rate, could grind to a halt if banks run out of cash. Publicly-traded companies won’t continue hiring if they see Wall Street fall off a cliff. All the economic progress seen since markets bottomed in the last recession March 9, 2009 could start over if the Fed gets reckless with QE3. Talking about “measured” steps in ending QE3, Bernanke doesn’t know whether or not banks are ready to go it alone without the Fed’s help. While adding to the national debt, QE3 has kept the economy rolling giving businesses enough cash to keep hiring.
Whatever happens in China and emerging markets, the Fed must proceed with caution before taking the U.S. economy off QE3 cold turkey. Today’s market seizures directly relate to an expected loss of capital from the Fed’s moves. Continued reductions in QE3 could plunge the economy into double-dip. While it’s a good sign that the unemployment rates dropped to 6.7%, robbing companies of stock market liquidity could cause unemployment to spike, forcing employers to scale back hiring. If Yellen continues to taper, the stock market could deteriorate rapidly, fulfilling promises of Wells Fargo’s Martin-Adams dire forecast. If there’s any consolation while markets adjust to reductions in QE3, Wall Street’s biggest bear, New York University Stern School economist Nouriel Roubini, sees strong growth in Europe and Japan while predicting slow growth here at home.
About the Author
John M. Curtis writes politically neutral commentary analyzing spin in national and global news. He’s editor of OnlineColumnist.com and author of Dodging The Bullet and Operation Charisma.