To stem the financial crisis of 2008, which threatened to cause a stock market and economic meltdown, the Federal Reserve embarked upon an aggressive program of buying bonds called quantitative easing (QE), causing interest rates to plummet and thus propping up the prices of financial assets as well as the economy. Last September, the Fed announced that it would start unwinding this policy, and Jamie Dimon, the chair and CEO of JPMorgan Chase, is one of many prominent figures in finance who warn that this reversal of direction could send stock prices plummeting and derail the U.S. economic expansion.
The Stock Market's Lofty Gains May End Soon
|Index||10-Year Gain||YTD Gain|
|S&P 500 Index (SPX)||119%||5.2%|
|Dow Jones Industrial Average (DJIA)||119%||2.5%|
|Nasdaq 100 Index (NDX)||288%||13.7%|
|Russell 2000 Index (RUT)||126%||8.7%|
Source: Yahoo Finance; data through the close on August 1.
Dimon's concerns about the risks from a reversal of quantitative easing have been especially attention-getting since he is otherwise bullish about the U.S. economy, and is typically positive about the market outlook. As he told CNBC, "The economy is quite strong...there are no potholes out there." Dimon's views are echoed by other leading figures in finance, as noted below. Meanwhile, a variety of high-profile figures such as former Office of Management and Budget (OMB) Director David Stockman and emerging markets fund manager Mark Mobius have been anticipating a major stock market pullback. (For more, see also: 'Daredevil' Stock Market Poised to Drop 40%: Stockman.)
Dimon: 'People Can Panic When Things Change'
On CNBC, Dimon said: "I don't want to scare the public, but we've never had QE [before]. We've never had the reversal [before]. Regulations are different. Monetary transmission is different. Governments have borrowed too much debt, and people can panic when things change." Per another CNBC report, Dimon warned in April that limitations on banks' capital and trading activities, such as those imposed by the Volcker Rule, might lead to larger swings in asset prices than in the past. He also indicated then that another risk comes from the possibility that the Fed might accelerate its program of interest rate increases in response to rising inflationary pressures.
No Rate Hike Now
Dimon's recent comments came before the Fed's August 1 policy announcement. While noting that economic growth and the job market have been strong, the Fed indicated on August 1 that it would not raise interest rates at this time, since inflation has remained near its target of 2%. All four stock indices listed above sank to intraday lows shortly before the Fed's announcement, then rebounded afterwards. (For more, see also: Fed Leaves Rates Unchanged, Stays on Course for September Hike.)
As reported by CNBC, in pursuing its policy of quantitative easing, the Fed increased its bond portfolio from $800 billion to $4.5 trillion. Meanwhile, other central banks followed suit, with the result being a mind-boggling $12 trillion injection of liquidity into the global financial system. In a policy reversal sometimes called quantitative tightening, the Fed is slowly unwinding its balance sheet by letting about $40 billion of bonds mature each month without being replaced, and central banks in other countries are pursuing a similar course.
Earlier this year, noted bond fund manager Bill Gross expressed his own concerns about the effect of this unwinding. Last year former Fed Chair Alan Greenspan warned of a massive bond market bubble that will be deflated in the process. (For more, see also: Bill Gross: QE is "Financial Methadone" and Stocks' Big Threat Is a Bond Collapse: Greenspan.)
Summers: 'Tightening Involves Real Dangers'
Regarding so-called quantitative tightening, CNBC has quoted other prominent figures. Former U.S. Treasury Secretary Lawrence Summers says, "tightening involves real dangers and needs to be carried out with great care." According to Peter Bockvar, the chief investment officer (CIO) of $3.5 billion asset management firm Bleakley Advisory Group, "I believe the market—with the S&P at an all-time high—is headed for a brick wall the deeper quantitative tightening gets." Ray Dalio, founder of hedge fund Bridgewater Associates, observes that quantitative tightening is bound to produce effects entirely opposite to those from quantitative easing, namely, "higher interest rates, wider credit spreads and very volatile market conditions."