The Federal Reserve has made its most aggressive move ever!
On Sept. 13, the Fed announced a third round of bond buying, called Qualitative Easing, or QE, increasing its purchase of mortgage bonds to $40 billion per month from the average of $15 billion per month that they were previously buying. They also announced that this is an open-ended program with no end date, and that their short-term rates would remain low until 2015.
In the past, the Fed has always put an amount that they would buy monthly, and also when they would stop. The Fed’s official statement noted that they would wait until unemployment had come down substantially before stopping the purchases, leading many of us to believe that they will keep the pedal to the metal even when they start seeing some good results.
Buying this amount of mortgage bond should reduce rates even lower than the record low rates that we are seeing now. The Fed is hoping to encourage American’s to invest in some riskier assets, such as real estate or equities, which would help to improve the economy.
The proponents of the move say that this is what we need to keep the economy moving in the right direction, while opponents of the move say that this will cause hyperinflation in the future and weaken the dollar. The Fed in essence is printing money in order to buy these bonds. Some can argue that the Fed has done a pretty good job of making money with their quantitative easing. The last two years, the Fed has averaged $70 billion in profits from the sale of the bonds that they had purchased in previous years.
The Fed’s move should be welcomed with open arms by the stock market, which has been looking to the Fed to continue to prop up equity prices and extend their gains from the bond purchases. When bond yields are at record lows, some investors will look to buy stocks instead of bonds to get a higher rate of return.
The Fed may have also moved in anticipation of the “fiscal cliff” that will occur on Jan. 1, 2013. What they mean by the fiscal cliff is that the economy could drop dramatically after Jan 1 because the “Bush Tax Cuts” — tax cuts that were implemented during the term that President Bush was in office — will expire, leading all taxpayers to pay higher taxes. This coupled with scheduled spending cuts by the government will push the GDP (Gross Domestic Product) down, and potentially back into a recession. J.P. Morgan Chase has referred to this scenario as falling “face first into a meat grinder.”
If this scenario happened, the stock market would drop and mortgage rates would drop yet again to another record low. Weak economic news will always bring rates down. Time will tell if the Fed’s aggressive measures will save us, or if we will be in for some harder, harder times.
We cannot continue to kick the can down the road, and we have to at some point take our medicine and figure out how to fix these problems. The last thing we want is for the U.S. to looks like Greece 10 years from now.
While I should personally benefit from QE3, I do not think that this will be the best way to get the economy going. The Fed only has a few tools and I truly feel they are doing the best they can with what they have.
Thanks, Ben Bernake!
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