The “noxious” policy of quantitative easing will be coming to an end, short rates will stabilize to around 2 percent, and as a result stocks and bonds will be stuck at higher valuations, said Paul McCulley, the former Pimco senior partner.
McCulley, a veteran central bank analyst and chairman of the Society of Fellows of the Global Interdependence Center, told attendees at the Altegris strategic investment conference in San Diego Thursday that QE helped avoid another Great Depression.
“I didn’t expect it to stimulate economic growth, so that’s the wrong measure” to evaluate QE, McCulley said during a luncheon address.
Nevertheless, the policy evokes a visceral negative reaction. To some, QE “is like a fat man in Speedos—it’s just wrong,” he said.
But QE has helped reduce debt, he said. A great deal of “the effective deleveraging [in the economy] is the equity market going up a lot. The easiest way to deleverage a system is to drive up equity values” and create capital gains.
QE has had a “nefarious, smelly” negative consequence: contributing to income inequality by benefitting the wealthy, McCulley said.
McCulley isn’t worried about inflationary risks from the Fed’s expanded balance sheet.
If inflation appears to be an issue, “the Fed just has to hike rates and slow the economy down,” McCulley said. “I’m not worried about the size of the [Fed’s] balance sheet. That means nothing.”
With a change in Fed policy, equity returns will be more muted, McCulley said.
“The extraordinary rise in equities that we’ve had is coming to an end,” he said. And “sometime in the next year the Fed is going to start normalizing the Fed funds rate. … I think they will stop at around two percent, which is dramatically lower than where they were prior to the crisis. So I think we have a structurally diminished short term interest rate, which means both bonds and stocks will have structurally higher valuations than they did prior to crisis.”
This transformation in Fed policy “is absolutely a good-news story for America,” McCulley said. “But it means that people who have been riding [the wave of] QE need to sober up.”