12/10/2012 7:15 PM ET|
How Fed's next trick will hurt bonds
Another bond-buying program seems likely as the Federal Reserve tries to boost the economy. But long term, it will lead to higher interest rates, inflation and bond market turmoil.
I think the Federal Reserve is setting up investors for a significant change in policy to be announced after Wednesday's meeting of the Fed's Open Market Committee.
The new plan would resume the rapid growth of the Fed's balance sheet and push it to $3 trillion sometime in 2013.
And that would make the big problem facing the Federal Reserve and the U.S. economy even bigger. After expanding its balance sheet by buying what will soon be an additional $2 trillion in debt to help stave off the worst effects of the global financial crisis and then to support a stumbling U.S. economy, how does the Fed shrink its balance sheet back to something like normal size without crashing the U.S. and global economies?
The Federal Reserve's Operation Twist is scheduled to expire this month. That program to swap about $270 billion in short-term Treasurys for longer-term, five- to seven- year debt in order to lower long-term interest rates – to support the recovery of the housing sector and to stimulate economic growth -- is almost certain to end with the year.
But Fed Chairman Ben Bernanke and company are also almost certain to replace Operation Twist with a new, more aggressive program of quantitative easing. The fallout from this will be new pressure on bonds that could eventually send investors fleeing -- and those who aren't careful will get hurt in the rush.
A new buying binge
The Fed is clearly worried that the debate alone over the fiscal cliff -- or worse, the actual expiration of all of the Bush tax cuts, the Social Security tax reduction and extended unemployment benefits, plus the automatic budget cuts imposed by the debt-ceiling deal -- could slow the economy and even send the U.S. back into recession.
Recent speeches by Federal Reserve governors and basic math all suggest the new program will be an out-and-out plan to buy five- to seven-year Treasurys. That would continue the thrust of Operation Twist but get around a big problem the Fed now faces: It has become increasingly difficult for the Federal Reserve to sell its short-term holdings of Treasurys and to buy medium-term debt to replace them because the Fed has effectively sold most of its short-term holdings.
The new program would require the further expansion of the Federal Reserve's already massive balance sheet, which stood at $2.85 trillion as of Nov. 21. That $2.85 trillion level has been relatively stable since June 2011.
The new plan would change that. The number floating around Washington and Wall Street mentions Fed buying of about $45 billion in Treasurys a month. That would easily push the Fed's balance sheet to more than $3 trillion sometime in 2013.
Amazingly enough, the Fed's balance sheet was at just about $1 trillion before the start of the current downturn.
The Federal Reserve's most recent plan for shrinking its balance sheet goes back to 2011. Then, the Fed projected that it might start selling off some of its holdings of Treasurys and other debt in mid-2015. That, if you remember, is also when the Fed might begin raising the short-term interest rates that it directly controls. Recent announcements from the Federal Reserve's Open Market Committee have promised that the Fed would keep short-term rates at their current 0% to 0.25% level until at least the middle of 2015.
Logically, this plan made some sense: If the economy was strong enough by mid-2015 to withstand the downward pressure of higher short-term rates, it should also be strong enough to face some selling by the Federal Reserve of its medium-term debt portfolio.
The science of printing money
Why does all this matter? It all goes back to the why and how of the Federal Reserve's manipulation of its balance sheet to begin with. By buying Treasurys or other debt in the open market, the Federal Reserve stimulates the economy by adding to the money supply and lowering the cost of money (by lowering interest rates). At least, that's the theory behind the Fed's programs as the economy struggles to pick up speed after the Great Recession.
The Federal Reserve pays for these purchases, essentially, by creating money with the government's printing presses. That's why its purchases of bonds in the open market add to the money supply -- those purchases are paid for with newly printed money. Seen from this perspective, the Fed's balance sheet consists of "assets," such as Treasury bonds, purchased with money conjured out of thin air.
The big problem comes when the economy starts to pick up speed. Then, all that created money that was intended to speed up growth becomes the source of inflation and threatens to push up not just prices (consumer inflation) but also the prices of financial assets (asset-price inflation). Neither is good. The Federal Reserve has a clear mandate to fight consumer-price inflation because rising prices eat away at the value of money, making the fixed returns on things like bonds less and less valuable and reducing the value of paychecks, too. Once the expectations of future inflation become ingrained, the rate of inflation can soar as everyone tries to raise prices or increase wages faster than the rate of inflation.
More from MoneyShow.com:
VIDEO ON MSN MONEY
OK how many times do I have to say this inflation is caused largely by the higher interest rates the Federal Reserve charges for money which in turn fuels higher interest rates businesses and people have to pay on loans. An increase of 5 percent in money a borrowed to run a company is going to be passed on as a 10 percent increase in what the business sales.
It is that simple. Why do you think we have have lower than expected inflation (expect for the bump higher fuel prices have had on transportation and growing food which the government does not track in the inflation numbers) when everyone said the low FED rate would cause massive inflation.
When business (big businesses) can borrow money at the Fed discount window for zero percent interest (see Microsoft as one) they feel less likely to increase their prices. When they have to borrow money at Citi bank at 5 percent interest they are going to charge 10 percent more to pay for the increase loan rates and make up for loss of customers due to higher prices and hedge for even more future interest rate hikes.
When the Federal Reserve finally starts to raise interest rates as they will as US economy gets weaker and weaker inflation is going to get worse and worse.
THEY HAVE TAKEN WEALTH FROM SAVERS AND GAVE IT TO THE RICH.
AT 6% ON CD'S OVER THE LAST 12 YEARS MY MOTHER WOULD STILL HAVE HER CD'S.
PLUS SENT A LOT OF MONEY (EARNINGS) INTO THE ECONOMY.
NOW THE CD'S ARE GONE. 2% ON HER MONEY WAS NOT ENOUGH.
WHO HAS HER MONEY? THE FED. AND THEIR BANKER BUDDIES
MULTIPLY MOM X THE NUMBER OF THE RETIRED. THAT IS WHAT HAS BEEN STOLED.
IF THE LOW RATE WERE TO CREATE JOBS LIKE THEY SAY. YOU WOULD THINK THAT AFTER 12 YEARS WE WOULD NEED SOME MORE MEXICANS.
I suspect that, in the long run, the sequence of events will be:
1) Economy recovers (eventually), liquidity fuels a new bubble, inflation goes up.
2) Interest rates rise, bonds crash suddenly, stocks rally.
3) 10-year rates reach 7-8% and still rising / stock market has major crash, PE ratios drop to single digits
4) Economy plummets
5) Rinse, repeat.
"Wach for signs of increasing expectations for rising interest rates. I think the interest-rate turn will be apparent first in the market for three- to seven-year Treasurys, and so these are the early warning signals you should watch."
Sensible, useful advice. Thanks
back door banking means low interest rates and failing banks, with the blessing of the rats.
Google "cloward piven strategy" and learn what's driving obama. His goal is the collaps of the US economy.
Quote "Federal Reserve's Open Market Committee have promised that the Fed would keep short-term rates at their current 0% to 0.25% level until at least the middle of 2015." When 2015 comes it will be more of the same. If you are trying to save money CDs, money market etc. you are simply out of luck. The FED will find some excuse to keep interest rates around zero forever. No one can depend on saved money for a retirement anymore unless you have a lot of it which most people don't. So live it up today since our government is going to make time down the road ugly.
In 2001 we had a $237 billion dollar surplus and a ten year projected $5 trillion dollar surplus that would have paid our national debt off. So what went wrong ?
Bush tax cuts $1.812 trillion in lost revenue
Afghan Iraq wars $1.469 trillion in un-funded war costs
Added Discretionary $608 billion in un-funded spending
TARP $224 billion in un-funded spending
Medicare D $180 billion in un-funded spending
2008 failed stimulus $773 billion in un-funded spending
8 year spending spree $5.07 trillion and a $1.3 trillion dollar deficit by 2009
Without revenue increases to pay for this spending spree, the fed has no other choice than to dilute the dollar, over spending caused the printing, not the federal reserve, stop the un-funded spending and we will stop the printing, it's that simple.
Oh-wait, one more thing:
Maybe the FED thinks that congress/Obama will not be able to reach an agreement before 1/1/13 ? Remember that they have to have it drafted by the 15th (that's in 4 day's) and reviewed & signed before the 21st when congress goes home for the holiday's.
I've got my 'parachute' ready, hope you do to- you're going to need it !
Copyright © 2014 Microsoft. All rights reserved.
Fundamental company data and historical chart data provided by Morningstar Inc. Real-time index quotes and delayed quotes supplied by Morningstar Inc. Quotes delayed by up to 15 minutes, except where indicated otherwise. Fund summary, fund performance and dividend data provided by Morningstar Inc. Analyst recommendations provided by Zacks Investment Research. StockScouter data provided by Verus Analytics. IPO data provided by Hoover's Inc. Index membership data provided by Morningstar Inc.
[BRIEFING.COM] The major averages continue holding modest losses with the S&P 500 down 0.2%. Even with the early retreat, the benchmark index is still higher by 1.7% this week and up 3.0% for the month.
Cyclical sectors continue to weigh, while all four countercyclical groups trade a bit ahead of the broader market. Heavily-weighted technology and financials will be in focus as the session continues, considering the two top-weighted groups have the potential to influence the overall ... More
More Market News
|There’s a problem getting this information right now. Please try again later.|
MUST-SEE ON MSN
- Video: Easy DIY smoked meats at home
A charcuterie master shares his process for cold-smoking meat at home.
- Jetpacks about to go mainstream
- Weird things covered by home insurance
- Bing: 70 percent of adults report 'digital eye strain'