June, 2013 Archives

6
Jun

Fed Exit Will Be Incredibly Complex

by Riaan Nel in Global Investments

 As of April the Federal Reserve had a balance sheet worth $3.295 trillion.  Remember, before the global financial crisis the Fed’s balance sheet was in the $600 billion range.  We’ve seen similar increases in relative terms by other central banks around the world.  Never before in the history of fiat currencies have we seen such an unprecedented increase in the global money supply.  I agree with PIMCO’s El-Erian that the Fed’s exit (or curtailment of its monetary stimulus) will be incredibly complex.

There are basically two schools of thought, those that believe that the exit could be smoothly managed, and those that think it will be messy, causing elevated inflation.  In the middle there are those of us that are just plain skeptical about how smooth the exit will be.  It very well might be smooth, but this notwithstanding, it’s going to be very, very complex.  I don’t foresee an exit anytime soon.  The Fed is currently buying $85 billion worth of Treasuries and agency mortgages with the aim of keeping long-term interest rates low to spur economic activity.  But you just can’t unwind a balance sheet of such magnitude without some kind of unforeseen consequences occurring.

If you believe the transition from economic growth through the Fed’s monetary stimulus to “genuine growth” (using El-Erian’s term) will be a smooth transition risk assets are the place to be; however, if you’re skeptical or think it’s going to be messy diversification is the name of the game.