The U.S. Federal Reserve wants to phase out its bond-buying program as early as this fall.
That only happens if the economy improves. And “that’s a big if,” says Patrick O’Toole, vice-president of global fixed income at CIBC Asset Management. He co-manages the Renaissance Canadian Bond Fund.
He adds, “The Fed’s forecast has generally been more optimistic than street consensus estimates, and it’s generally been wrong.”
O’Toole reminds investors QE was initially implemented to “get the mortgage market back on its feet; get interest rates a little lower; help on the refinancing side; and spur some activity in the housing market. And then when they started buying treasuries as well, it was to convince investors it was safe to go into riskier assets.”
Specifically, the Fed wanted to keep interest rates low so people would buy riskier assets like equities, which would help a virtual recovery.
O’Toole says the Fed hoped this extra wealth would boost business confidence, meaning companies would “hire more workers, and those workers would [support] the economy. It’s had some success, but only in creating wealth in the stock market, and that hasn’t filtered down.”
He concedes, though, that “the economy is perhaps better than it would have been [without QE], but…markets have to get back to an environment where fundamentals are dominating how markets behave,” rather than being dependent on central banks.
Currently, O’Toole says “bond yields are moving higher and stock prices have softened up a little bit, [but] it’s been much more of a violent reaction in the bond market” than the Fed may have expected following their most recent meeting and conference.
That’s because investors are adjusting to a range of yields, he adds. What’s more, he finds the economy is less in need of stimulus than it was at the beginning of this year, meaning a shift is underway that’s causing market volatility.
O’Toole stresses the Fed was right to be concerned about issues like the fiscal cliff and payroll tax hikes at the beginning of 2013. He adds, “It was worried these [issues] could cause a material slowdown in the economy, so it put its foot down on the gas pedal a little harder to start the year [with] QE3. [Officials are] now realizing things aren’t as bad as feared, so they’re letting up.”