Economic Outlook: FED to Buy $1.2 T in Government Debt, Mortgage Securities
The FED, our nations central bank, announced midday on March 18, 2009 that it would purchase $300 billion in long term government bonds over the next six months. Furthermore, they said they will buy up to $750 billion in mortgage backed securities guaranteed by Freddie Mac and Fannie Mae, as well as an additional $200 billion worth of debt issued by those two quasi governmental housing agencies. The current intent of the FED is to keep long term interest rates at relatively low levels for an extended period of time. When there is strong buying of government bonds, the interest rate levels decline as buyers are willing to take less return on their investment in exchange for the peace of mind in holding government bonds. When government bond yields drop, other types of interest rates also trend lower. Therefore, auto loans, business loans, mortgage rates, and even credit card interest rates may be impacted.
Immediately after the announcement, the stock market rallied, the US dollar dropped against the value of other major currencies, and gold prices moved upward by 5% in one day. While it is clear that the intent of the FED is to keep rates low in order to further add stimulus to our economy, it is most important to look at the reactions to their efforts. The reactions give a broader picture of what to expect going forward. The dollar fell in value because dollars on deposit in the US or invested in US bonds will earn a lesser return due to lower interest rates here. The Euro currency and the British Pound, for example, each gained substantially against the dollar because investors will earn greater rates of return on capital invested in those countries where interest rates remained higher. As foreign currencies gain in value over the dollar, their purchasing power is greater and American exports tend to increase as foreign buyers will be more active in American export markets.
The theory continues; if US exports grow, the employment outlook will improve and as people go back to work they will in turn have more money to spend. Additionally, lower interest rates allow for easier access to funds for small businesses and corporations who have been locked out of the credit markets since the financial crisis began last year. All of this easier money may have the effect desired by the FED, which is to further stimulate economic activity from industrial production to exports to housing and to consumer spending.
Of course, the key to success under this scenario lies in the ability of the FED to know the precise moment to begin raising interest rates and tightening the flow of money. While most would believe that any tightening of money supply wont occur in 2009, and maybe not until late into 2010, the danger of double digit inflation rates such as those experienced in the late 70s and early 80s looms large over the barely recovering economy. The current climate in financial markets remains very cautious, as may well be expected. Stock markets remain volatile and that causes confidence levels to remain low, which in turn will impede any rapid return to business as usual for most Americans.
In an earlier article I discussed Americans poor savings habits as compared to those of other nations. Interestingly, our savings rate has increased over the last four months. This phenomenon is another of what I call leading indicators. Historically, when savings rates begin to increase, previously volatile markets begin to stabilize, and after a period of stabilization they are able to consolidate and eventually grow again. Those who use these times to review personal spending, pay down debt, and generally tighten their belts in order to set aside some savings have generally fared well as a recovery takes hold. The pending tax cuts for the majority of Americans will take affect beginning with lowered tax withholding rates in April. Paychecks will be slightly larger and that affords everyone fortunate enough to be working the opportunity to salt those dollars away and be ready to take advantage of future opportunities. As long as the FED keeps a close eye on the reactions to their efforts and moves in measured paces, it is possible that this latest move will help to resolve the current financial crisis more quickly.
©Patrick J. Catania 2009
The views and opinions expressed herein are solely those of the author and do not necessarily reflect those of Baxter Credit Union, its Board of Directors, or its employees. The author is responsible for the content. Readers should consult with, and seek professional advice from their own attorneys, accountants, and financial advisors with respect to their individual financial needs and circumstances.
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