The only thing the Fed accomplished today was to create a deflationary environment for interest rates. And just as in any deflationary situation, it’s a killer for the economy.
The problem here is that the Fed has not gone far enough because all they are doing is rolling over Treasuries, or recycling Agency principle payments into Treasuries, while keeping the amount of assets held on the balance sheet level (i.e. they are not printing).
What they are trying to do is to drive down interest rates on things like residential mortgages, which they believe will spur more people to buy homes. But the theory is entirely wrong and if you don’t believe me, then answer the following questions:
1. Do you think interest rates are going higher or lower over the next few months? Most will say lower because if the Fed is buying, it is likely that the increased demand will raise prices and lower rates.
2. Are you more apt to purchase something now if you believe the price will be higher or lower next week? Of course you will wait until next week because you want to get a lower price.
Now for the big question-If you are one of the lucky few looking to buy or refinance a house, are you going to do so now when you expect that rates will be going down further over the next few months? Of course not! You are going to WAIT a bit for a better interest rate!
That is what a deflationary environment does; it forces people to delay their purchases as they wait for a better price. Or look at things this way-home sales accelerated when people were convinced that the tax rebate was ending. Why? Because people will buy now (assuming they can) if they believe that price is going up in the near future.
Aside from that, if the Fed’s balance sheet is not being expanded it means they are not printing. And if they are not printing, they are not depreciating the dollar and therefore cannot create higher values in assets like stocks, homes, etc. Remember, it wasn’t until Bernanke was interviewed by 60 Minutes back on March 15, 2009 and “admitted” they were “electronically printing” that things really took off. It is a very simple relationship-depreciate the dollar and anything that is bought with dollars has to go up in price.
What their plan is also bound to fail miserably at is create jobs. I mean, what, someone who owns a business is going to hire more workers because the rate on Treasuries is going down? What they are doing does not make any sense and it is bad monetary policy because nothing is being done for the employment portion of the dual mandate.
Additionally, because they are trying to create a bond rally, other asset classes like stocks are bound to suffer from the competition. But then again, more Americans than ever are keeping their money in bonds so perhaps they will have a chance to see some appreciation.
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