Pimco's El-Erian: Unwinding Fed's Bond Buying Will Have 'Collateral Damage'

Wednesday, 01 May 2013 08:09 AM

By Michael Kling

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The Federal Reserve will struggle to unwind its giant bond-buying program, says Pimco CEO Mohamed El-Erian.

Although the Fed’s program of purchasing $85 billion of Treasurys and mortgage securities has benefits, it also poses risks and unintended consequences, El-Erian warned while speaking at a panel discussion at the Milken Institute Global Conference in Los Angeles.

It may not be able to end its massive bond buying without “collateral damage,” he said.

Editor's Note:
Economist Unapologetically Calls Out Bernanke, Obama for Mishandling Economy. See What They Did

“Right now we are seeing distortions in markets,” he explained. “Resources are being misallocated. And already, there are already concerns about bubbles. That’s what gets broken in this journey.”

If genuine, unassisted growth returns, those concerns will fade, but the Fed’s bond buying may not be effective in restarting genuine growth.

“It’s a fifty-fifty proposition,” El-Erian cautioned, saying that explains why there’s so much excitement and anxiety in the market now.

“The Fed will exit under two conditions: either because they are successful or because they become ineffective,” El-Erian noted.

Other speakers on the panel also expressed concerns about the Fed’s bond purchasing.

“I don’t think the central banks or the Fed have thought about how they’re going to get out of the trade,” said Terry Duffy, the executive chairman of CME Group. “I started trading at 21 years old. You always have to have a vision of how to get out of a trade before you get in. The Fed needs to do that before they get in any deeper.”

Minutes of the Federal Reserve meeting last month indicated that policymakers seemed headed to winding down their bond purchasing before a weak March jobs report took them by surprise, according to Reuters. A few of the 12 Fed members hoped to start decreasing the purchases this summer and end them by the end of the year.

“Several others,” the minutes stated, according to Reuters, “thought that if the outlook for labor market conditions improved as anticipated, it would probably be appropriate to slow purchases later in the year and to stop them by year-end”

Board members discussed how to lower the Fed’s balance sheet, which has ballooned from about $800 billion to over $3 trillion, but reached no consensus.

“These minutes would really be alarming people if we had not had a weak [March] non-farm payroll,” Michael Jones, chief investment officer of Riverfront Investment Group, told Reuters. “These minutes seem more strident, there are more voices cautioning about the exit strategy than in prior minutes, and the language is more precise.”

Editor's Note: Economist Unapologetically Calls Out Bernanke, Obama for Mishandling Economy. See What They Did

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