Economist Pento: When Fed Ends QE, Look Out

Wednesday, 30 Apr 2014 07:29 AM

By Michael Kling

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Elimination of the Federal Reserve's monthly asset purchases, known as quantitative easing (QE), will cause a stock market collapse and severe recession, predicts one economist.

That's because the Fed's tapering has ended QE's "wealth effect," which supported rising asset prices, writes economist Michael Pento, president of Pento Portfolio Strategies, on his blog.

In QE, banks have been selling higher-yielding Treasury and mortgage bonds to the Fed in return for "Fed credit" that pays a 0.25 percent rate, he explains. Banks then purchase bonds, stocks and real estate to attain higher yields but also because they expect the Fed to support prices by continuing to purchase huge amounts of assets.

Editor’s Note: 5 Shocking Reasons the Dow Will Hit 60,000

"Of course, most on Wall Street fail to understand or refuse to acknowledge that ending QE will cause asset prices to undergo a necessary, but nevertheless healthy correction," writes Pento, who predicts a brutal recession starting later this year.

The Fed, which was buying $85 billion of bonds a month, began tapering this year, hoping to reduce its purchases by $10 billion at each meeting.

"Real estate and equity values have already lost their momentum, as the Fed is removing its massive support for these assets," Pento writes. Stocks are down and home prices dropped 0.33 percent, according to the Case-Shiller index. New home sales fell three months in a row and plummeted 14.5 percent in March.

"But Wall Street will try to convince investors that the spring allergy season — also known as the pollen vortex — is unusually bad this year," he writes. "Therefore, nobody wanted to go outside and purchase a new home, even after all the snow melted."

Market strategists think new banking lending will replace the Fed's asset purchases, but stricter regulations and higher capital requirements will stifle bank lending, he says. Plus, consumers are not motivated to borrow more, as household debt remains high and real disposable income is not growing.

Most experts don't share Pento's outlook. New Federal Reserve Chair Janet Yellen is off to a good start this year, says Villanova University Associate Professor of Economics Victor Li in an article for US News.

The transition from former Fed Chairman Ben Bernanke to Yellen has been smooth, and growth of QE asset purchases has dropped by a third, he notes.

"These actions have alleviated concerns that Yellen would steer the Fed toward a more dovish direction — meaning looser monetary policy — and these actions demonstrate her commitment to return the Federal Reserve’s enormous balance sheet to normalcy."

Editor’s Note: 5 Shocking Reasons the Dow Will Hit 60,000

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