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By Jeremy Glaser | 04-12-2013 11:00 AM

Walsh: Could Get Bumpy When Fed Tightens

Although the Fed is likely to keep policy very loose through the end of the year, the unprecedented nature of the intervention means we can't tell what the disruption to financial markets will be when the Fed pulls back, says Western Asset's Steve Walsh.

Glaser: Let's take a closer look at the Fed; that seems to be a big driver of the market right now. Will they be able to gracefully exit from their extremely accommodative policy right now, or is this going to be a bumpy road? 

Walsh: Jeremy, that's the $64 question. Again, you see what's going on around the world and the recent announcement in Japan. To a certain degree what's going on in the United States is an extraordinary monetary experiment, and experiments can end OK and they can end more troubling.

We can't, you and I, can't sit down and say, OK, Steve, let's analyze the four or five historical incidents when central banks did a similar thing. This is fairly unprecedented. Actually what is absolutely unprecedented is the Central Bank having to back away from this. It's really just the Bank of Japan that has ever, even pre this recent announcement, has had such extraordinarily aggressive monetary policy. They haven't had to back away yet, because they've been in the soup for almost two decades. 

So I think you'd find Western Asset a little bit more in the "bumpy road" camp. Obviously, that's maybe a little bit of a higher probability outcome for us, and importantly, I think investors ought to try to think through what a bumpy road it might look like when we ultimately ever--and I think we all hope that one day the Fed has to back away from these policies. But they are such a big part of the marketplace, and I don't think anyone who follows financial markets, stocks, bonds or otherwise, can look at the last three or four years and say, wow, markets [haven't] been really impacted by the low interest rates, i.e., zero, and by the $3 trillion or $4 trillion Central Bank balance sheet, and the $85 billion a month that we're currently buying. Most people would probably say, well, gosh, that's probably kept rates a little lower than they would otherwise be, and it's probably--again, got investors to invest in other fixed income sectors, which has brought down spreads.

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