QE comes to an end

On Wednesday afternoon, the U.S. Federal Reserve announced that it would end its long-running quantitative easing (QE) program at the end of October 2014. In its statement, Fed officials cited “solid job gains” as well as “sufficient underlying strength in the broader economy" as the basis for its decision. At the same time, the Fed continued to assure investors that short-term interest rates will likely remain near zero for a “considerable time” and that any rate move will be data-dependent.

We have been wary of the potential long-term consequences of the Fed’s bond-buying program since it began and, now that it's nearly complete, we remain skeptical of the program’s effectiveness. Certainly the labor market and the economy have improved since the start of the program in 2008. Yet much slack still remains, particularly when looking at wages or broader measures of unemployment. Further, QE has been an extraordinarily expensive way to inflate prices on risk assets, as the Fed’s approximately $4.4 trillion balance sheet indicates. So, where do we stand now that the program is nearly complete?

Despite the fact that current bond prices and a range of forecasts point to tightening as a high probability for the second or third quarter of 2015, we believe that weak global growth should keep real rates at very low levels for the foreseeable future and deflationary pockets in key world markets should keep nominal rates low as well. Market forecasts for significantly higher rates and a steeper yield curve seem to be misplaced. If anything, we believe that forecasts should acknowledge the potential for a return to 10-year Treasury rates in the low 2% range. That said, the Fed statement’s lack of a dovish tone, despite the recent bout of market volatility, was notable to us. Furthermore, it is interesting that the Federal Open Market Committee downplayed the recent move in market-based measures of inflation, instead preferring to note surveys measuring inflation expectations. This implies to us that the central bank remains on course for a mid-2015 rate hike unless the data forces a change.

The views expressed represent the Manager's assessment of the market environment as of October 2014, and should not be considered a recommendation to buy, hold, or sell any security, and should not be relied on as research or investment advice. Views are subject to change without notice and may not reflect the Manager's views.

Investing involves risk, including the possible loss of principal.

Fixed income securities and bond funds can lose value, and investors can lose principal, as interest rates rise. They also may be affected by economic conditions that hinder an issuer’s ability to make interest and principal payments on its debt.

Funds that invest in bonds may also be subject to prepayment risk, the risk that the principal of a fixed income security that is held by the Fund may be prepaid prior to maturity, potentially forcing the Fund to reinvest that money at a lower interest rate.

For broker/dealer use only.

For institutional use only.

10/14 (13508)

Notes from the desk

Visit archive Visit archive Visit archive