Stocks High, Junk Bonds Low: Is It the Fed's Doing?


Washington Post columnist Neil Irwin stopped by to discuss his book, The Alchemists: Three Central Bankers and a World on Fire. It's a great read on the history of central banks, including how they responded to the financial crisis and the challenges they face in the future.

In this video segment, Neil offers his views on high stocks, low junk bond yields, and whether the Fed will be able to implement its exit strategy successfully -- and at the proper time. A full transcript follows the video.

Morgan Housel: How much of stocks at record highs and junk bond yields at record lows is directly attributable to Fed policy, do you think?

Neil Irwin: I think quite a large proportion. Now, there's two things to separate out.

How much of it is Fed policy in the sense of, the Fed's doing QE to two trillion-something dollars in QE that's happened over the last four years, and that money that's pumped into the financial system finds its way into different fixed-income and equity securities, that props up prices? There's clearly quite a lot of that. There's no question that's a major thing.

But the other aspect of it is, how much has the overall approach of monetary easing helped the real economy, and therefore earnings are higher, there's more real activity going on in the economy, and therefore the fundamentals justify higher prices for equities and other securities?

I think it's mostly the first. I think it's mostly, you pump $2 trillion into the economy, it's going to go somewhere. That somewhere is the stock market and different debt markets.

But I think there is also some genuine improvement in how the economy is doing, so if you look at price earnings ratios in the stock market, it's not totally out of whack. If you look at it compared to Treasuries, it's actually quite desirable, quite a good buy.

Morgan: How worried are Bernanke and the Fed that this will all end badly?

Neil: I think Bernanke himself has a pretty good deal of confidence that they can handle this exit. He'll probably be gone by the time the exit strategy is time to be implemented, but look, their job is to be cautious.

If you're a central banker, you don't get to be a central banker by being a fly-by-night, do things in a very loose, poorly thought-through manner. They're trying to do some rigorous analysis on how can we do this exit strategy? How will it work? That's what's ongoing at this very moment.

They think they have the technical tools to do it. The question for me is not so much will they have the technical tools. I'm pretty confident they will. If there's one thing the Central Bank knows how to do, it's to raise interest rates.

The question is, will they have the political will and have the analytical skill to get the timing right?

Political will in the sense that you have to imagine the day comes, they're raising interest rates, we still have large deficits ... it's politically inconvenient for Congress to suddenly have higher interest expenses and all that comes with it.

Then the judgment -- getting the timing right. You do it a year too late, you're an inflationary Fed Chairman, you're not a very good Fed Chair. You do it a year too early, you cause more human misery and a longer recession than we needed.

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