Impact Of The Federal Reserve Buying $600 Billion More In Treasuries By Second Quarter of 2011

On 11/3/2010 the US Federal Reserve announced it is committing $600 billion to buy more government treasuries/bonds in order to stimulate the weak US economy.  This is the second massively large and unconventional program of quantitative easing (money printing).

In the statement released by the Federal Open Market Committee (FOMC) it said that although spending and investment have been rising in some areas in general, it still remains weak and slow.  They stated that “the pace of recovery in output and employment continues to be slow”.   High unemployment has “constrained” consumer and household spending due to “modest income growth, lower housing wealth, and tight credit”.   They also sited that corporate/business spending has increased less than the previous year, and employers “remain reluctant to add to payrolls”.

The Federal Reserve intends to “purchase a further $600 billion of longer-term Treasury securities by the end of the second quarter of 2011, a pace of about $75 billion per month”. The Committee also said it will “regularly review the pace of its securities purchases and the overall size of the asset-purchase program” to reflect new information going forward and adjust the program as needed.  The size of the new program takes aim at trying to keep deflation at bay, as “measures of underlying inflation have trended lower in recent quarters”.  The central bank also intends to keep overnight rates low for an extended period, in order to aid in easing up credit.

In its statement, the Federal Reserve Bank of New York indicated that approximately 86 percent of the purchases would be distributed across Treasuries with maturities ranging from 2-1/2 to 10 years. It will also temporarily “relax the 35 percent per-issue limit” on the Fed’s holdings under which it has been operating and be allowed to rise above it “only in modest increments”. The New York Fed has also been directed to continue reinvesting maturing assets (principal payments from agency debt and agency mortgage-backed securities) into longer-term Treasury securities, approximately $250 billion to $300 billion.  Taken together, the New York Fed expects to purchase $850 billion to $900 billion in Treasury purchases.

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WHAT ARE THE IMPLICATIONS OF THIS SECOND MASSIVE PROGRAM OF QUANTITATIVE EASING?

Much like the fist time, the Fed proceeded with the new program of quantitative easing to largely avoid deflation, and help the economy grow and eventually recover.  [See Implications Of The Federal Reserves Purchase of Treasuries]

However, the US is heavily in debt with the total growing each day.  The current US debt is approximately $13.7 trillion.  That number does not include the future costs of Obamacare either (Obama’s health care plan).  It also does not include the expected additional $221 billion for Fannie Mae & Freddie MacThis new quantitative easing program sends the country significantly further into debt as it is largely spending money it does not have (excluding the reinvestment of assets).  This printing of money has already devalued the US dollar, and will continue to do so.

Originally, I had expected the US economy to start growing at more decent levels approximately 3 years (2011) from the first quantitative easing and bank bailout.  However, we can see that the original stimulus was not enough and the economy is still very fragile.  Significant traction in economic recovery may be unlikely next year and be pushed back even further.  A few years after the economy has recovered to a state where it might be really growing at a healthy rate again, we should start to see inflation increase more significantly.  A high inflationary environment (high rates) will be an eventual outcome. Although, we may be years away from that, the law of economics will prevail unless the US can act fast enough (unlikely) to limit the effects.

However, that being said investors have already moved away from US dollar into other nations currencies and economies, particularly emerging markets. As a result, their currencies have risen, threatening exports and undercutting their competitiveness.  Many nations have intervened in foreign exchange markets and initiated policies to curb capital inflows. Japan’s cabinet approved 5.05 trillion yen ($62 billion) in new economic stimulus, and also reverted to a zero interest rate policy, as the Japanese yen is reaching 15 year highs versus the US dollar.  Recently, Thailand imposed a 15% withholding tax on capital gains and interest income from foreign investment in government debt in a bid to curb the Thai baht, which is at its highest since the 1997 Asian financial crisis.  The People’s Bank of China slowed the rise of the Chinese yuan by setting a weaker midpoint reference rate for trading a few weeks ago. China insists that the yuan must rise gradually. Brazil had doubled a tax to 4% on foreign portfolio inflows into bonds and some other financial instruments to reduce upward pressure on the Brazilian real.  The Bank of England’s David Miles stated “We do have a policy tool, quantitative easing, which remains a potentially powerful tool and one that we might come to use.” as Britain also contemplates such measures to deal with the competitive pressures.  Singapore surprised many nations by widening the trading band for its currency.  India’s central bank intervened in its currency by buying US dollars to slow the rise Indian rupee. The Reserve Bank of India has been reluctant to intervene in currency markets, but may be forced to again as foreign investors are expected to pour in billions of dollars into the nation to buy shares of Coal India, in the country’s largest ever IPO.

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WHAT SHOULD INVESTORS DO?

The global currency battle is intensifying, and this move by the Fed is another reconfirmation of the relative level of weakness in the global economic recovery.  As a result, commodities (hard assets) in general, and commodity related investments have been increasing in price and will continue to increase. Gold in particular (as well as other previous metals such as silver, and palladium) will continue to attract investors (individuals, institutions, and governments) on a global level for a number of years.

Savvy investors should take advantage of the impact that the quantitative easing and economic conditions will have and profit. Here are some articles containing more background knowledge that opportunistic investors can read in order to take advantage of this situation:

How The Financial Crisis Will Affect The US Dollar, Inflation, Gold, and Oil Prices
Implications Of The Federal Reserves Purchase of Treasuries
Why Investing In Gold Can Be Profitable, And When The Gold Bubble Will Burst

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Official Releases:

Federal Open Market Committee (FOMC):
http://www.federalreserve.gov/newsevents/press/monetary/20101103a.htm

Federal Reserve Bank of New York:
http://www.newyorkfed.org/markets/opolicy/operating_policy_101103.html
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Thanks and Happy Investing!

Author: The Investment Blogger

I’m a private investor, who developed the “function-centric investing” paradigm. I am an investor who blogs a little here and there, rather than a blogger who invests a little here and there. I'm passionate about investing and sharing investment knowledge!

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