US Videos

Volpert: Diminishing Returns From Fed Action

Timothy Strauts

Tim Strauts: I'm Tim Strauts. Today I'm here with Ken Volpert, head of Vanguard's Taxable Bond Group. We're here at the Morningstar ETF Invest Conference.

Thanks for being here, Ken.

Ken Volpert: You're welcome, Tim.

Strauts: So, Ken, what is your opinion of the Federal Reserve's latest new moves with QE3?

Volpert: So, the QE3 is really related to a continued slow economy--very poor employment growth and just ongoing challenges to get this economy moving. And QE3 is really an attempt to continue to keep asset prices higher, create a little bit of a wealth effect, maybe that would result in more consumer spending and hopefully generate a little bit more growth in the economy.

I think every QE that goes on actually is less effective. So, I'm not sure how much more will be generated out of QE3, compared to the first and second QE in the Twist, which I think were much more effective than this is going to be.

Strauts: Some people are calling this QE Infinity, because it's an open-end bond buying program. Now why do you think Bernanke choose to do an open-ended program?

Volpert: Well, I think, he did a couple of things in this announcement. Not only did he make it open-ended and go after mortgages, to try keep the housing market growing and a little bit stronger, but he also really emphasized that he's not going to take it away very quickly. Even if the economy starts gaining employment, it starts improving, he’s going to continue to do QE beyond what I think investors generally thought.

So, QE Infinity is just probably about right, [in the sense] that it's going to go on for a very long time. And I think that kind of changed a little bit investors' take on how long rates will stay low, and it seems to be pushing further out any kind of rate increase.

Strauts: Now, the fiscal cliff is coming up here, with automatic tax increases across the board, and it seems to be the general consensus that if that actually happens that we're going to move into a recession pretty quickly. Do you have any thoughts on what’s going to happen with the fiscal cliff?

Volpert: We do think that we're going to go over the cliff for a little while. It does seem like Congress and the president can't come to an agreement, and so it does feel like until they get to a crisis point, they can't get anything done. So, it wouldn't surprise us at all that we actually go into the New Year still without a deal. And there is also some thought that the fact that we get into the New Year, then taxes go up, they didn't do it, and then if they do put in some cuts that it looks like they actually cut taxes.

Read Full Transcript

So, there is some game-playing, potentially, that would go on in terms of how it's framed and how they would be able to talk about it. So, it shouldn't be that surprising if we actually go over the cliff, but we don't expect it to last very long.

If everything goes through, all the tax increases and spending cuts, it's about $600 billion, which would be huge, and definitely would take us into a recession. Our guess is, when it's all said and done, it will be about $250 billion, which still is going to get us in the first quarter of next year pretty close to a recession, and depending on what other kinds of factors happen in the economy, we could see a mild recession early next year.

But our base case is, actually, we kind of cruise through just over recession levels.

Strauts: At last year’s ETF conference we were talking about Europe, and it seems today that Europe is still a problem. So, is what Europe is doing now improving situation, or are they just kind of kicking the can down the road?

Volpert: Well, I think part of the strategy is to kick the can down the road. I think Merkel, her approach seems to be to let the crises happen and that can get them to actually get the peripheral nations, the Southern European nations, to do more around getting their fiscal house in order, etc., getting their competitiveness improved. So, it feels to me like Germany now has declared--especially since Merkel disagreed with the head of the Bundesbank around the whole ECB purchases of Spanish debt--the fact that she did that seems to say that she is willing to really support the euro in a very big way, but there needs to be some very serious action by the Spanish and Italian governments before she’s willing to actually go on the line to do it.

So, I think what ultimately is going to happen here is that Spain will make a request to the euro region for aid, and then the ECB will buy a lot of the secondary debt and the special fund that was set up by the European Union will then also provide funding for the primary debt for the new issues that come to the market from Spain, and it will help get them through the re-funding cycle that they have of debt.

So, it's definitely a good outcome, and I think you've seen that in terms of yields in Spain and Italy have come down quite a bit from where they were a few months ago. And I think there's been a little bit of a … risk-on trade … in the risky assets, and a little bit of a flight away from quality in the Treasury market in response to that.

Strauts: Now, if I'm a U.S. investor, and I don't own any European debt or don’t own any European stocks, how does what's going on in Europe affect my U.S. bond investments?

Volpert: So, the way it would affect it is, Europe is a very large counterparty for a lot of our trade, a trading partner, and if their economy is going into a deeper recession, they are going to be buying fewer goods from us. So, I think that's … a very important implication. I think the European banks also own a lot of our assets, a lot of our investments, investments in our markets, and if they're de-levering because of the crisis, they're going to be selling our assets and that might cause riskier assets to perform poorly.

So I think there are those kinds of implications that could affect how our assets are priced and how our economy grows going forward. So, it is very important to that Europe continue to get their act together around greater fiscal union that ultimately will provide some more stability for all the markets around the world.

Strauts: Well, Ken, thanks for being here and for all your insights.

Volpert: You're welcome, Tim.

Strauts: For Morningstar, I'm Tim Strauts, thanks for watching.