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Wall Street Feels Pain of China’s Credit Crunch, Federal Reserve Uncertainty

June 20, 2013 at 12:00 AM EDT
It was a bad day for global markets, whose stocks fell over worries about a credit crunch in China and comments by Federal Reserve Chairman Ben Bernanke that the fed may begin paring back stimulus efforts. Jeffrey Brown gets reactions from The Wall Street Journal's David Wessel and James Paulsen of Wells Capital Management.
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TRANSCRIPT

JEFFREY BROWN: And we pick up on the market’s fall today.

For that, we’re joined by David Wessel, economics editor of The Wall Street Journal, and James Paulsen, chief investment strategist at Wells Capital Management.

And, David, let me start with you.

One of the big things at issue here, of course, is the Fed. Explain what investors are reacting to.

DAVID WESSEL, The Wall Street Journal: Well, yesterday afternoon, the Federal Reserve ended a meeting, and they said they were a little more optimistic about the economic outlook.

And Fed Chairman Ben Bernanke said that the Fed would keep buying $85 billion dollars a month in Treasury bonds and mortgages, but that it planned, if the economy performs as he expects it to, to begin paring that back later this year and to stop this bond-buying by the middle of next year.

And he also said that short-term interest rates, the ones that we get on our bank deposits, the ones that banks pay each other overnight, will remain low for a long time. And he tried to say if the economy doesn’t perform as we expect, we will rethink our plan.

Well, basically, investors must have thought, oh, my gosh, the day has come when the Fed is going to start to make the U.S. economy and the world economy go cold turkey on all this easy money, and they — nobody wants to be the last guy out of the market. And so they reacted very, very swiftly, more than I suspect the Fed anticipated.

JEFFREY BROWN: Well, James Paulsen, that is a question. It’s not really — is it really such a surprise? Because everyone knew at some point the Fed would do this.

JAMES PAULSEN, Wells Capital Management: I don’t think so, Jeff.

I think that part of the big response that David speaks to has to do with the fact that we have come up so much, I think, in the last year. We had a really big run, 25 percent, 30 percent run. Often, in big bull markets, you have very violent, but short-term sort of pullbacks. And I think this was a catalyst that allowed traders to sell, the excuse to sell.

I do think that people calm down a little bit, and we adjust to a little higher bond yields that we’re seeing here in the last few days as the Fed stops buying many as many bonds, I think we will calm down and realize that the Fed’s real message is that the economy to them is looking a little better, and they think for the first time the economy can get along with a little less support from them all on its own. As an equity investor, that’s probably a good thing.

JEFFREY BROWN: Well, David, that is the paradox here, isn’t it? We get excited because the market drops so dramatically, but the Fed is doing this in part because it thinks the economy is getting better.

DAVID WESSEL: Exactly. No, that is a paradox.

So, if Jim is right, and people begin after a couple days to realize, you know, this is really good news, we want to live in an economy where the Fed doesn’t have to be keeping interest rates near zero forever and where we bump along at such lousy growth, then people could come to their senses.

I think there are two possibilities for less-good outcomes. One is that the markets overreact, and that hurts this very fragile recovery. Look at housing. So mortgage rates are up quite a bit. They’re at the heist level in 14 months. They’re still low by historic standards. But if mortgage rates keep going up, will that hurt the housing market? And will that make — will it rain on the Fed’s forecast?

The second thing is, we — this doesn’t happen in a vacuum. The rest of the world is always changing, and there were a couple of changes today. One is China seems to be having some problems. They’re trying to step on the brakes, have less credit available to their economy, but they have just even more trouble than the Fed at figuring out exactly how to do that smoothly.

So, we saw short-term interest rates rise abrupt abruptly in China at the same time there was a report that factory output is down. And then every day there seems to be another headline out of Europe, sometimes good, sometimes bad. Today was a little worrisome that maybe there was some tension between Greece and the International Monetary Fund.

So, this all comes at a time when the rest of the world is very unsettled.

JEFFREY BROWN: Jim Paulsen, pick up on the China part of that in particular. How do you interpret what happened there and why it had such an impact on our market?

JAMES PAULSEN: Well, personally, Jeff, I think China is the biggest risk, rather than the Fed.

I think the slowdown in the emerging world, led maybe by China, is heavily influencing global export markets, particularly United States, and it’s one of the reasons that manufacturing is the weakest part of our economy at the moment here, not our consumer or housing industry. Our domestic industries are doing fine. I think the emerging world is holding back our production side.

So, that’s a bigger issue. Personally, I think that it’s become more of a crisis pitch in China might be a good thing, because it might — as David says, it might get policy officials in that region to ease more in the face of that and maybe turn that situation around a little bit.

If I could say one thing about interest rates here …

JEFFREY BROWN: Sure.

JAMES PAULSEN: … I think the reason that rates are going higher in this country is because we’re finally getting more confident about the future.

You know, so which to me is better? Is it better to have a three percent mortgage, but most of us are scared that Armageddon is just around the corner? Or is it better to have a 3.5 percent mortgage with most of us starting to feel more comfortable about the future?

I think higher rates with the more comfortable general populace about the economic future is a much better situation than what we had even with lower rates earlier.

JEFFREY BROWN: Well, David, that goes — that sort of all depends on where you’re sitting, right? So, our viewers who are watching, it depends on their particular position, whether they’re watching the market, whether they want to buy a house, et cetera.

DAVID WESSEL: Well, that’s, of course, true. There’s always winners and losers.

And if you’re putting money in the bank, and interest rates go up, you’re happy, and if you’re borrowing money and interest rates go up, you’re not happy. But I think Jim makes a very good point. If this is a an abrupt and unsettling step towards a more normal economy, where the Fed doesn’t have to provide so much credit, where the private sector is able to grow a little better each month than it did the month before, that is the world we want to get to.

Everybody wants to be in a place where the U.S. economy is strong enough for interest rates to be more normal. The question is, are interest rates rising too fast, getting ahead of the Fed and getting ahead of the economy? Or is this a symptom of an improving economy? And I don’t see — think we really know now. People have different views on that. We will have to see what happens.

JEFFREY BROWN: We will watch.

David Wessel and James Paulsen, thanks, both, so much.

JAMES PAULSEN: You’re welcome.

DAVID WESSEL: Thank you.