Less Fed Intervention Would Be Good for the Economy
John P. Calamos Sr.
June 16, 2013
With 15 consecutive quarters of economic growth, a strengthening housing market and other improving data, investors are now increasingly focused on what happens when the QE (quantitative easing) party begins to wind down. I think markets are—as they often do—looking at things from a "glass half empty" perspective. The Fed will be most likely to back away from QE because the economy is showing sustained signs of improvement. It would be time for the crutches to come off the patient.
Yes, when the time comes, tightening the spigot will be complex given the magnitude of the easing. But that same magnitude also provides the Fed with considerable flexibility. QE isn't an "on-off" switch. Decision makers at the Fed are well aware of the task at hand and I believe that they will act deliberately.
If history is any guide, a reduction in QE will likely cause choppiness in the markets, but I believe that ultimately, less Fed intervention will benefit the economy, longer term. While decisive action in response to the Great Recession was understandable, the ongoing role of QE3 in the recovery is debatable.
As the chart below shows, the Fed's actions have contributed to a dramatic increase in money supply. The problem is that money hasn't moved through the economy at anything close to a commensurate rate, as illustrated by a decline in the velocity of money.
The amount of money in the U.S. economy has increased, but the money hasn't moved.
Too much of the money from QE is sitting in the banks. Smaller businesses still struggle to get capital because there’s little incentive for the banks to lend to them. So, how do we speed up that velocity? Moderately higher rates would provide the much-needed carrot. More normal rates (say, a yield of 4% rather than 2% for the 10-year Treasury) have historically been associated with higher P/Es. (For more on this, read the recent post from my Global Co-CIO, Gary Black.)
Of course, inflation is a concern. The worse-case scenario associated with an end to QE would be a repeat of the 1970s, when inflation came roaring back. But inflation seem seems well contained within the U.S. economy at this point. As we noted, the Fed doesn't have to take an all-or-nothing approach, and instead can moderate its course as it goes.
Inflation remains below 2% target
To look at it another way, think of the economy as a train. The Fed may think it's driving the train—and many investors may think so as well. But small business is the engine of job creation, and in turn, lasting economic health. Stoking the engine of small business is overdue.
The opinions referenced are as of the date of publication and are subject to change due to changes in the market or economic conditions and may not necessarily come to pass. Information contained herein is for informational purposes only and should not be considered investment advice.
The information in this report should not be considered a recommendation to purchase or sell any particular security.