Tags: federal reserve | taper | stock market | correction

MHT MidSpan's Holland: Fed Tapering to Spark 13 Percent Market Correction

By    |   Wednesday, 05 February 2014 06:42 PM

Stock markets may see a steeper correction due to the Federal Reserve's tapering of quantitative easing (QE), but the economy won't be hurt, says Murray Holland, managing director of MHT MidSpan.

The Fed tried to use large-scale asset purchases, commonly referred to as QE, and a zero interest-rate policy (ZIRP), to spur the economy and lower unemployment.

But their most notable accomplishment was the creation of a “ $3 trillion funds flow-stream” to the capital markets, Holland writes in CNBC commentary.

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Therefore, if the recent 4 percent correction can be used as a gauge, the impact of further tapering is likely a larger correction of perhaps another 13 percent or so, he projects.

When it comes the economy and the labor market, QE has been “a big zero” says Holland, so tapering isn't a major concern.

The Fed spent trillions purchasing assets from banks, who in theory, were to use the money to make loans. As the fund went into other banks, they were also expected to lend, hence the term money-multiplier.

But the Fed's gamble didn't pay off. The money-multiplier has averaged 8.2 times over the past century, but now stands at a historic low of 3.0, explains Holland.

For all of the Fed's spending, little of the money made its way into the economy, much less created jobs.

According to Holland, part of the problem is that the Fed started paying interest on bank reserves, so banks weren't motivated to take too many risks making commercial loans.

ZIRP had a positive effect; it lowered interest rates, which made it cheaper to borrow. But, Holland says the nation's debt levels are already so high that there's little demand for debt.

Limited business debt means weak economic activity. Add the negative impact of the 2013 tax increase, the Obamacare employer-mandate and the massive numbers of retiring baby boomers, and that's an equation for decades of slow growth, Holland projects.

The Fed's tactics made investors and Wall Street happy, but “a frothy equity market is not one of the Fed's mandates,” and it's high time for the Fed to try something else, Holland writes.

Fed economists have long debated the effectiveness of QE and the risks of it creating asset bubbles. There appears to be a consensus that it's time to change course.

Last month, the Fed announced another $10 billion per month reduction, lowering its monthly asset purchases to $65 billion. It was the first meeting without dissent from any members since June 2011, Bloomberg reported.

“They really want to move to the sidelines here and get out of the (bond buying) business,” Jack Ablin, chief investment officer at BMO Private Bank, told Reuters.

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Stock markets may see a steeper correction due to the Federal Reserve's tapering of quantitative easing (QE), but the economy won't be hurt, says Murray Holland, managing director of MHT MidSpan.
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2014-42-05
Wednesday, 05 February 2014 06:42 PM
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