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December 26, 2013 at 07:54 AM
The Federal Reserve laid out definite plans to move away from quantitative easing last week, and the stock markets kept marching along.
The Dow Jones Industrial Average, in fact, is set to end the year with its biggest percentage gain since 1996. If the index ends 2013 above 16,422.11, it will top its 25.32% gain of 2003, making it the Dow’s best year since 1996 (when it climbed 26.01%).
But don’t crack open any champagne for a longer-term uptick in the markets, says Mohamed El-Erian, CEO and co-CIO of PIMCO.
“Central bankers have good reason to be more cautious about declaring victory at this stage. And the rest of us would be well advised to ask why,” he declared in an opinion piece in the Financial Times on Thursday.
Quantitative easing, El-Erian points out, “is widely believed to have significantly bolstered asset prices and, to a lesser extent, helped the real economy too.” And central bankers have made it clear that “policy interest rates would remain floored for quite a while.”
In fact, they’ve signaled that cuts to interest paid by the Fed to banks on excess reserves might be trimmed if needed. So why be cautious?
One, Fed policy is “overly dependent on using artificially high asset prices to alter household and company economic behavior,” according to the PIMCO executive.
It could be using other avenues, such as the credit channel and movement of cash into real economic investments. Concerns should continue “until the Fed witnesses improving economic fundamentals that validate artificially-elevated asset prices,” he points out.
Indeed, economist George Perry of the Brookings Institute said as much earlier this week in an article on his outlook for 2014. In that piece, Perry pointed out that the so-called wealth effects or impact from the rising stock market and strengthening home prices were “not reliable predictors of consumption.”
