Fear of End of QE Overhangs Markets

Terry Flanagan

The prospect of the Federal Reserve ending its quantitative easing program is creating uncertainty in the markets, despite the Fed’s signals that it’s unlikely to do so anytime soon.

At her confirmation hearings on Thursday to succeed Ben Bernanke as Fed chairman, Janet Yellen said that she remained of the view that the Fed’s $85 billion per month bond purchasing program was having a salutary impact on the economy.

“Our asset purchases have made a meaningful contribution to the economic outlook. It is important not to remove support while the economy is still fragile,” Yellen said in response to a question. “It’s also important to withdraw accommodation when the right time comes. I do not see the program continuing indefinitely. There is no set time when we will reduce the quantity of our purchases, but we do monitor progress at each meeting.”

Still, the prospect of the Fed possibly beginning to unwind its QE program is hanging over the market.

“It’s totally a narrow, institutionally-driven market. It’s been fueled by the Fed, and the biggest fear is the taper. If taper happens, it will be ugly,” said Kathy Boyle, founder and CEO of Chapin Hill Advisors, which provides financial planning and risk management for families, family offices and high net worth individuals. “We’re in a peaky, frothy part of the market, and the risk to the downside is greater than the potential for gain. The savvier the family and the higher the net worth, they more they tend to agree with me.”

The irony is that smaller investors are clamoring to snap up equities because they have missed out on previous market rallies.

“The average investor is chasing the market,” said Boyle. “They feel like they missed the boat. We have clients that have stayed on the sidelines and watched the market run up, and now they want to get in. They were afraid to get in in 2009 and 2010, and now they want to get in.”

As of last week, $231 billion had gone into equity mutual funds since the beginning of the year. “That’s a huge amount of money by any standard, no matter how much you hear about cash being on the sidelines,” Boyle said.

Volatility is at a depressed level, another warning sign. As of midday Thursday, the VIX was 12.48, down from 12.52 at Wednesday’s close. “The VIX is still extremely flat, reflecting complacency in the market,” said Boyle.

The outlook for the fixed income market is also clouded by the Fed’s monetary policies.

“The dilemma is that there is more risk in the bond side than most people recognize,” said Boyle. “The worst case scenario is a rising interest rate environment, with a taper. Last Thursday’s drop was triggered by a 2.8% GDP, which was stronger than the consensus, and also by the fact that the ECB unexpectedly cut rates. The thought pattern was if Europe is coming back, then why did they need to cut rates?”

“Japan is trying to inflate its way out,” she continued. “They’ve had ten years of stagnant growth and many people are afraid that we’re going to be another Japan. It’s scaring a lot of people. Radiation is another major issue, which will cause health and business problems. Japan will be dealing with the fallout from Fukushima for years to come.”

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