Ah, yes. Now it all makes sense. Now we know why the U.S. Federal Reserve has not begun reducing its monthly purchases of Treasuries and mortgage-backed securities. They foresaw the trouble that a government shutdown and possible debt default would cause the economy.
They even eluded to it in their press release after their latest meeting last month. “Taking into account the extent of federal fiscal retrenchment,” they blamed, “the Committee decided to await more evidence that progress will be sustained before adjusting the pace of its [monthly] purchases.”
So now we are all awaiting “more evidence,” as in more economic reports confirming the economy is strong enough to walk on its own without the helping hand of continued monthly stimulus.
Only we have a problem here. There are no new economic reports. And there won’t be any until some while after the government reopens again, whenever that will be.
The next Federal Reserve meeting is scheduled for October 29th – 30th, much too soon to begin bond tapering. What about at the December 17th – 18th meeting?
Economists are not so sure, warning that far too much damage may have been dealt to the economy to allow a curtailing of stimulus this year at all.
“Lingering uncertainty – let alone a fiscal accident – would raise the chances that the Fed does not taper until next year,” predicts Ethan Harris, global economist for Bank of America Merrill Lynch, in a research note obtained by CNN Money.
Others say it could be longer than that, perhaps even years. Would you like some more punch?
Feeling the Fed’s Frustration
The whole purpose of Fed stimulus – which includes two massive injections of cash known as Q.E. 1 & 2, plus the current ongoing monthly bond purchases known as Q.E. Infinity – was to repair the damage caused by the 2008-09 financial and housing crises; namely, to lower the unemployment rate and revive the housing market.
But after 5 years of injecting liquidity into the economy by purchasing over $2.8 trillion worth of U.S. Treasuries and mortgage-backed securities, the Federal Reserve’s employment and inflation targets are still nowhere near satisfied.
The Federal Reserve has been pretty ticked off at the government all year long, especially since the sequester kicked in – those indiscriminate budget cuts straight across the board. You can feel the Fed’s frustration getting hotter by the month with each press release:
March 20th: “Fiscal policy has become somewhat more restrictive,” they wrote when the sequester first began.
May 1st: “Fiscal policy is restraining economic growth.”
June 19th: “Fiscal policy is restraining economic growth.”
July 31st: “Mortgage rates have risen somewhat and fiscal policy is restraining economic growth.”
September 18th: “Mortgage rates have risen further and fiscal policy is restraining economic growth.”
Of course, part of the blame for rising mortgage rates is to be laid at the Federal Reserve’s own feet, as they spooked the markets into dumping bonds when they announced in May that they were looking into reducing their monthly bond purchases, or Q.E. Infinity.
For some two months now, these higher mortgage rates have begun negatively impacting the housing market, cooling the buying and threatening to slow the housing recovery.
Then came a series of blows on the employment side, including a surprisingly weak non-farm jobs number on September 6th, downward revisions to the two previous jobs reports, and a weak private jobs report on October 2nd.
Amidst all that came weak consumer sentiment surveys and expectations within the retail sector of a dismal holiday shopping season ahead.
If all that weren’t enough to cause the Fed to shelve its Q.E. tapering plans, we have the still ongoing government shutdown, with Moody’s Analytics estimating the closure could end up costing the American economy some $50 billion in lost production, effectively wiping out nearly three weeks of Fed stimulus right there.
And the Fed must be getting even more anxious, as each day passes without a congressional agreement to raise the government’s credit limit, potentially causing the government to default on its debt payments, which could in turn send the dollar for a tumble and plunge the economy into another recession.
The Road to Recovery Just Grew Longer
Given so many dangers, some wouldn’t be surprised if stimulus actually increases. “If the government shuts down for an extended period and there is a default that leads to a big, negative impact on the economy, the Fed could increase QE,” proposes Lance Roberts, CEO of STA Wealth Management, to CNN Money.
Of course, even if Congress fails to agree on a borrowing limit increase by the October 17th deadline, default can still be averted by diverting funds away from government employees and contractors to cover foreign debt payments.
But that contingency plan, while solving one problem overseas, would only create another one back home, as former chairman of Goldman Sachs Asset Management, Jim O’Neill, warned to Bloomberg: “The cutting would be so huge it would put the U.S. back into recession.”
Even if Congress does come to an agreement on time to raise the debt limit and reopen the government, the series of blows already dealt to employment and housing since May may have delayed the economic recovery enough to push stimulus reduction and interest rate normalcy several years back. One expert expects the Fed’s easy money policy to remain in play… for decades.
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“The United States (and global economy) may have to get used to financially repressive — and therefore low policy rates — for decades to come,” Bill Gross wrote in his latest monthly newsletter obtained by CNN Money. Manager of the $250 billion Pimco Total Return (PTTRX) bond fund, and unofficially crowned “Bond King,” Gross may know a thing or two about interest rates.
The expectation in the marketplace is that the Fed will likely begin reducing its monthly bond purchases in early 2014, whittle them to zero by mid 2015, and then slowly begin raising interest rates later that year.
But Gross advises investors to “bet against that” happening. Citing the sharp burst higher in interest rates from May to September – when the 10-year Treasury yield jumped from 1.6% to just over 3.01% – Gross notes how yields quickly retraced back to 2.6%, which he believes is a clear indication that the economy is not yet strong enough to leave the Fed’s protection.
“The economy peeked its head out its hole like a groundhog on its special day and decided to go back inside for another metaphorical six weeks. No spring or summer in sight at those yields,” CNN Money cites Gross.
Yet others argue the economy’s delayed reaction to stimulus could still post strong number into year end, thus giving the Fed the all-clear to start tapering in 2014 and finally end Q.E. by 2015.
Gross contends that even so, an easy money policy will remain in place for years. “If you want to trust one thing and one thing only,” he continued, “trust that once Q.E. is gone and the policy rate becomes the focus, the fed funds [rate] will then stay lower than expected for a long, long time.”
If the economy has been dealt enough blows these past few months to stumble its recovery, and if Mr. Gross is correct that easy money will continue to flow from the Federal Reserve, then the party investors have enjoyed these last five years should continue for several years more.
Everything we have witnessed over the past five years of stimulus should continue. Since the worst of the 2008-09 crisis, the S&P 500 is up 145%, and gold is still up over 80% despite its recent 30% correction.
Bond funds are also up, like the iShares iBoxx $ High Yield Corporate Bond ETF (NYSE: HYG), which is up over 47% excluding its 5.8% annual dividend yield. Even U.S. Treasuries are up, with the yield on the 10-year falling from 4.1% then to 2.7% now.
Meanwhile, the U.S. Dollar Index (DXY) has fallen from 89 in March of 2009 to 80.45 this morning, as those $2.8 trillion in Fed purchases have expanded the money supply and thinned out the dollar’s value.
With Yellen having supported the FOMC’s accommodative measures in the past, it is likely she will stay the course the Fed is currently on. Even with three more changes to the Federal Reserve Board expected in 2014, it is likely the FOMC will continue predominantly dovish. In the six FOMC policy meetings held so far this year, current easy-money policies were voted for almost unanimously, with only 1 dissenter out of 12 members in five meetings, and 2 dissenters out of 12 members in one meeting. The group will likely remain decidedly dovish.
If you have not had your fill of equities, bonds, and gold, now may be a good time to top up your glass. The easy-money party is likely to continue for a few more years to come.
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