The Federal Reserve has been signaling that it’s prepared to begin tapering its quantitative-easing programs, but what happens when QE ends is anyone’s guess. Tad Rivelle, TCW’s chief investment officer and managing director of the firm’s fixed-income group, argues that while there are a few possible scenarios that might unfold here, the most likely one does not involve a happy ending. Instead, Rivelle, who oversees more than $80 billion in fixed-income assets, told ETF Report’s Cinthia Murphy that we’re more likely to be headed into a double-dip recession, albeit not severe, than into an economic boom in the near future.
Following is an excerpt from an interview conducted with Rivelle that will run in its entirety in the October issue of ETF Report. Rivelle will be a keynote speaker at IndexUniverse’s Inside Fixed Income Conference Oct. 18 in San Francisco.
IU.com: What are some of the potential macroeconomic scenarios you see unfolding in the near future, and what should investors do in these possible scenarios?
Tad Rivelle: Everyone understands that the pricing in the capital markets is reflective of the financial repression, quantitative easing, zero rates and everything else that goes with that. The big issue of the day is, When quantitative easing ends, what’s going to happen in the bond market, and in the capital markets, generally? In a sense, this is a two-part question because it largely depends on how you think quantitative easing is going to end.
For instance, according to the Fed’s hopes and dreams, QE is going to end in a strong, robust economic prosperity, lots of job creation, etc. Under those types of conditions, investors should be limiting interest-rate exposure, and favoring the credit side of the fixed-income markets; which is to say, corporate bonds, bank loans, maybe some high-yield paper. Non-agency mortgages work pretty well in that scenario too.
There’s another way that QE can end, and that’s not the way the Fed intends it to, but in our estimation it’s more probable. To put a number to that probability, let’s say there’s a 25 percent chance it ends the way I just described—in a good way—and there’s a 50 percent chance it is going to end badly.
Ending badly essentially means that the side effects of the medication are causing more harm than are the ostensible benefits. Rather than seeing much in the way of labor market improvement, what we are actually seeing is a rather substantive run in pricing in asset markets, and to a certain degree we’re also seeing significant changes with respect to the issuance of high-yield bonds—the lower-quality ranges are being issued, toggle structures are coming to market again. Basically, we’re seeing conditions we haven’t seen since 2006, before it [financial crisis] all began.
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