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Many attribute the stock market’s meteoric rise to the liquidity provided by the world’s central banks.In an interview with CNBC, Kashkari tells everyone to calm down because the Fed won’t be tightening anytime soon:
“Every time the Fed tries to back away from their massive, easing policy, the risk markets react. We saw that last week with the FOMC minutes. This is …like a morphine drip. You give morphine to the patient, it makes the patient feel better, it doesn’t cure the underlying disease. The moment you try to take the morphine away the patient wakes up horrified in a lot of pain.
And so I think risk markets are getting addicted to this easy money policy, and I think as the Fed tries to back away risk markets are going to respond, that’s going to put more pressure on the Fed to act. So our central forecast is the Fed will stay easing, maybe even QE3 through the end of 2014 as they forecast, could be even longer.”
Many have also attributed the stock market’s run to soaring profits. In his latest note, Kashkari warns there are five key catalysts that could cause profits to plummet.
- Increase in labour costs – labour costs account for 70 per cent of the total cost of production and if competition for labour pool increases this would hurt profits. For now though this doesn’t seem to be a real risk.
- Economic slowdown or recession – If the U.S. or global economy were to enter another recession corporate profits and stock prices would take a hit. But Kashkari’s base case is for a “muddle-through scenario”.
- Dollar strengthening – A strong dollar would hurt the profit margins of U.S. exporters but would be positive for companies that produce goods for sale in the U.S. His base case is for a “long-term secular decline of the dollar”.
- Cost of capital increase – If borrowing costs or costs of raising equity capital increase then profit margins could be vulnerable. That could in turn slow the company’s growth or see it contract. But the Fed is likely to keep interest rates low till 2014 and the ECB will likely have to continue its aggressive monetary stimulus.
- Increased corporate taxes – Higher taxes could hurt profits but this is highly unlikely.
Having said that, Kashkari said he does not think profits are at risk of collapsing. While many risks remain, Kashkari said for the equity market as a whole, corporate margins are expected to stay strong in the near-term.