June 22nd, 2011
05:21 AM GMT
New York (CNN) – In just over a week Ben Bernanke and his colleagues at the Federal Reserve will turn off the life support system that has kept the U.S. economy alive for the last two years. How will the markets respond? It’s anyone’s guess.
Optimists, like former White House Advisor Laura Tyson, say the economy - though still fragile - has healed enough to breathe on its own. The Fed has been clear about its intentions to end its program of buying treasury bonds and mortgage-backed securities, the market had time to prepare and the withdrawal of quantitative easing should end without much drama.
But executives at Pimco, the world’s largest bond fund, disagree. CEO Mohammad El-Erian is sticking by the firm’s bearish and controversial call that the end of quantitative easing will spark a sell-off in U.S. treasury bonds. I talked with both Tyson and El-Erian ahead of the Federal Reserve’s June meeting and he gave the following assessment.
“When a big buyer steps away, and the Fed has been a very big buyer, any investor has to ask the question who else is going to be buying and we can’t find another big buyer to step in. We are worried that other things being equal - and that is a critical aspect, other things being equal - that means higher interest rates unfortunately.”
Of course, all things aren’t equal. The prospect of a Greek default and fears about what that would do to the European banking system has sent investors running to U.S treasury bonds causing interest rates to drop, not rise.
That is a problem for Pimco investors who have missed out on the recent rally in treasuries. But it provides a window of opportunity for U.S. lawmakers who are struggling to reach a compromise to cut spending and get their deficit under control.
“I believe it would be much better for the economy, much better, if we could get the deal now,” said Tyson.
“I think there is great danger to kicking it beyond the (presidential) election, both in term of the world not believing the U.S. is ever going to get serious about its long run problem but also serious because we won’t able therefore to do anything about the short-term headwinds. This is a very important moment for action.”
Will EU and U.S. politicians step up? El-Erian is not that confident. “We encourage people to be cautious. Have dry powder. There will be opportunities because markets tend to overreact, but this is not the time to take massive risk.”
Can officials around the world prevent another global meltdown? Anybody brave enough to be buying here? Let us know your thoughts.
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