The howling can officially end. All the people crazy-mad about the Fed printing money (gold bugs, inflationistas, etc.) can ease their blood pressure and go back to their normal lives. On Wednesday, October 29 the Fed announced that it was no longer initiating new positions in U.S. Treasurys or mortgage-backed securities.
Even though the Fed isn’t growing its balance sheet anymore, it has pledged to keep its balance sheet at the current size. Whenever a bond matures or pays off early, the Fed will have to replace it. This might sound mundane, but the Fed has over $1 trillion worth of bonds maturing in the next five years. That’s not chump change.
Still, does it make a difference?
I don’t think the Fed is ending Quantitative Easing (QE) because it succeeded, I think they have pulled the plug because it doesn’t work… at least, not the way the Fed wanted…
The program provided tremendous support for the markets in its first iteration back in 2009. Not only did the Fed unfreeze the mortgage-backed bond market by purchasing securities, it also provided confidence to market participants that they wouldn’t be left holding unsold inventory. The initiative also drove down mortgage rates, which was part of the goal. But beyond some confidence and lower interest rates, what did QE2, Operation Twist, and QE3 (or infinity, whichever you like) actually do for us?
Homeownership fell to the lowest rate in over 30 years, so lower long-term interest rates haven’t goosed the housing market. Borrowers have cheaper money, which has given Apple and other big companies a cheaper cost of borrowing, but all they did was buy back their own shares. Consumers can borrow at cheaper rates, but other than student loans (which don’t count because they have set rates) and a boost in sub-prime car loans, debt hasn’t been rising.
All that said, lower interest rates have had one tremendous, long-term effect. They stole money from savers.
Every time the Fed bought a bond, it used money it had not earned to compete with other bond buyers. The competition drove interest rates lower than they would have been without the Fed, which means the other bond buyers paid more for the bonds than they would have if the Fed wasn’t buying.
For everyone that bought a bond over the last six years, this means you. Your interest rate was lower than it would have been if the Fed wasn’t using newly printed dollars to buy bonds as well.
At first glance, this might lead a person to think rates will spike higher, but that’s not very likely. If the Fed had ended QE before 2014, then maybe rates would have jumped. But now the global economy is slowing, with China missing GDP growth targets and the countries of the euro zone falling toward deflation. In this environment, it’s more likely that rates stay low and even fall further.
With QE off the table, the investing world now turns its attention to their other intervention policy — keeping short-term interest rates between 0% and 0.25%. The Fed announced this rate would stay low for a “considerable time,” without defining what that meant.
Is it six months? Nine months? A year? No one knows.
All we can do is wait for the Fed to tell us. But they did give us one hint. Their latest press release stated that their policies remain data driven, which means the Fed is looking at each release of unemployment, GDP, etc., trying to determine what it should do next.
If that doesn’t give you comfort, you’re not alone.
We expect more volatility in the equity markets in the months ahead, as everyone tries to figure out if the latest economic statistic is good enough, or bad enough, to change Fed policy.
Welcome to the world of a more transparent Fed. It’s unfortunate that we don’t like what we see.