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Second Thoughts About Easy Money

February 25, 2013

Concerns surround the possible impact of QE on the prices of non-equity assets, including high-yield bonds, agricultural land and mortgage real estate investment trusts, creating “bubbles” in other types of assets.
-Bernie Williams, VP of discretionary money management, USAA


In last week's Market Commentary, we highlighted the unprecedented level of quantitative easing, essentially money printing, by major central banks as a tailwind for risk assets such as stocks and bonds. This tailwind has been strong enough to offset continued weakness in economic conditions in the developed world, helping to fuel the rally in risk assets.

However, on Wednesday afternoon financial markets reacted to minutes from the Federal Open Market Committee meeting Jan. 30 that indicated growing concern among a number of committee members about the risks involved from the Fed's ongoing quantitative easing program of asset purchases. Concerns include the possible impact of QE on the prices of other assets, including high-yield bonds, agricultural land and mortgage real estate investment trusts. In other words, is the Fed simply creating "bubbles" in other types of assets?

This increasing level of hawkishness raised speculation that the Fed's QE policy could be ratcheted back before a substantial improvement in labor markets has taken hold. Stocks slumped after release of the FOMC minutes, with the S&P 500 falling by almost 1.25% on the day from its recent five-year high, with weakness extending into Thursday trading as well. Perhaps Fed Chairman Ben Bernanke will clarify the Fed's intentions during his semiannual testimony to Congress on Feb. 27.

For the President's Day holiday-shortened week, the S&P 500 index closed at 1,516, down 0.2%. Anxiety over another showdown in Washington, this time over the March 1 budget sequester cuts, also likely cast a pall over stocks. This is the first week this year that the S&P 500 did not finish higher. The yield on the 10-year U.S. Treasury note dipped back below 2%, falling 0.04 percentage points to close Friday at 1.97%. The most actively traded futures contract for gold fell by 1.8% on the week to close at $1,581 an ounce.

The week saw another round of mixed U.S. economic data. Housing starts for January fell by a lower-than-expected 8.5%; however, building permits increased by a better-than expected 1.8%. Existing home sales reported later in the week met expectations.

Initial claims for unemployment rose more than expected last week and the Philadelphia Federal Reserve's February index of business activity fell to its lowest level in eight months.

Inflation at the wholesale and consumer levels, as measured by the U.S. Labor Department, remained quiescent in January. The Producer Price Index rose 0.2%, and the Consumer Price Index was unchanged for the month. These numbers will continue to provide comfort to Bernanke as he looks to build support for continuing the Fed's QE program.

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