from Tim McLaughlin, VP Weichert Financial Services
It has been a little over a week since the FOMC came out with its $600 billion bond buying program. Many of you have asked -> how exactly will it work? The Fed, although it does not print money per se, effectively does so by expanding its balance sheet (currently triple the size of what it was in 2007). The Federal Reserve Bank of New York, acting as the agent of the Fed, will buy $600 billion of government debt by next summer, a chunk of which will come from the expected $250 to $300 billion of income/early payoffs from the $1.25 trillion of mortgages it purchased earlier this year. Most of those government securities will be in the 2 to 10 year range, which is the part of the Treasury yield curve that helps most to determine mortgage rates.
Given supply and demand, as the Fed buys Treasuries, the rates on those securities should fall, and it is
believed that rates on mortgages, corporate debt and other loans pegged to the Treasury securities will also drop, The underlying thought is that cheaper loans will push Americans to spend. And if companies start to spend and expand, it will lead to more hiring, etc….you get the picture.
However, this week proved interesting for the markets. There was a knee jerk reversal in the marketplace. The Fed’s latest “quantitative easing” program (QEII), which was designed to bring down interest rates, was not working at the front end of the week, and we witnessed some interest rates moving up instead. Rates, which rise as the price falls, have risen lately as investors (particularly foreign investors) avoid US government debt, including a new 30 year bond auctioned on Wednesday. That generated a great deal of market anxiety that the Federal Reserve has lost control ofrates and inflation expectations. In reality, it was a clear
message from the other constitutes of the G-20 (a group of 20 industrial and developing nations) that they were not pleased with the latest moves by the US Fed and Treasury that have negatively impacted their currencies and economic leverage in the marketplace. In reality, the short term market reaction may be all for not. The New York Fed will begin buying today with purchases of $6 to $8B, according to a schedule released by the central bank on Wednesday. By Dec. 9 it plans to have bought about $105B in Treasuries.
Having such a big, unflinching buyer in the market should keep prices high and yields low for some time. But it is a good reminder that what is supposed to happen (low rates) doesn’t always happen.