The End Of QE2 – Should We Worry?

| March 3, 2011 | 0 Comments

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!

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.

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Category: Bonds

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The Dynamic Wealth Report works with a number of staff writers and guest experts who specialize in everything from penny stocks to ETFs to options trading. These guest analysts post under the 'staff writer' moniker for ease of use.

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