Obama Pleased with Fed as Junk Bubble Looms

April 13, 2016Monetary Policyby EW News Desk Team

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President Barack Obama was reportedly pleased with a closed-door meeting with the head of the Federal Reserve, but investment banks warn that junk bonds are in a bubble as corporate profitability collapses.

A private, secret meeting between Obama and Federal Reserve Chairwoman Janet Yellen was a success, according to White House Spokesman Josh Earnest. “The president has been pleased with the way that she has fulfilled what is a critically important job,” Earnest said, adding that the Fed’s independence remains intact even as the Congress calls for more oversight of the independent central bank.

In the first meeting of its kind in a year and a half, Obama and Yellen discussed the economic difficulties the middle class is facing in the United States, although critics note that both the administration and the central bank have done little to help them.

With declining real wages over the past two decades and a decline in high paying jobs, many economists warn that income inequality and a lack of opportunity for advancement is keeping aggregate demand back.

In an attempt to bolster the middle class, President Obama has made some controversial initiatives, like the Trans Pacific Partnership. While nearly universally praised by economists as an important step in the direction of global free trade, critics point out that America’s counterparties to the agreement have run high trade deficits with America and have shown little interest in buying American goods.

Some countries, like South Korea, have seen their trade deficit with America skyrocket after independent free trade agreements were made to lift demand for American-produced products in Asia.

Another Fed Reserve chief—Philadelphia President Patrick Harker—said that the Fed needs to “get on with” raising rates as a stronger American economy is justifying making borrowing costs for financial products, like mortgages and car loans, more expensive for Americans.

A Junk Crisis

Elsewhere, commentators are warning that high debt loads and renewed demand for junk bonds are creating a new crisis that remains unaddressed by both American legislators and the Federal Reserve.

The largest bond market participant in the world, BlackRock, raised alarm bells as Larry Fink, the firm’s CEO, warned that negative interest rates, which are becoming increasingly popular as a form of easy monetary policy, are creating “incentives to reach for yield, pushing investors into less liquid asset classes and increased levels of risk.”

Speaking about over-high demand for junk bonds and other high-yield assets, Fink warned that negative yields will just exacerbate the problem.

At the same time, Swiss bank, UBS warned that a hunt for yields has pushed prices for junk bonds too high. In a note to clients, UBS analysts warned that junk bond buyers are “not being compensated for credit risk” as an economic slowdown and low yields in safer bonds push money into the high yield credit markets.

UBS warned that higher default rates would cause these investors significant losses. “The fundamental problem is that the default risk is exponential, not linear, in these securities,” the bank warned.