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What's Next on the Fed's Plate?

Interest-Rates / Quantitative Easing Oct 06, 2011 - 05:46 AM GMT

By: Dr_Jeff_Lewis

Interest-Rates

It's safe to say that the Fed's latest announcement won't be enough to get Wall Street fired up.  In a decision designed to minimize the long run cost of money, the Fed's so-called "Operation Twist" has been a nonstarter for Wall Street.


The Fed has yet to learn, or at least give mention to, the real problem facing the economy: stagnant growth, except in sovereign debt.  As the Fed seeks to minimize borrowing costs, investors wonder how they're ever going to justify making investments now that money is cheaper than it was one month ago.  The problem, of course, isn't that going out into the future is expensive; it's simply unknown territory.

Making the Case for New QE

Interestingly, those who have done best in 2011 have been the funds most directly invested in US Treasuries.  Ben Bernanke has made every bondholder cash rich at the cost of attractive long-term cash flows.  As bond yields dip, prices rise, and investors have to consider whether they should lock in their gains now, or wait for maturity, earning little more than 1.8% to payout for 10-year Treasury Notes.

Obviously, there is more to quantitative easing than just bond rates.  Bernanke himself admitted that quantitative easing was designed to boost asset prices as a whole.  A rising tide, Bernanke believed, would raise all ships, and ultimately the economy.

But now that the Fed's Operation Twist is proving to be another blunder in terms of jumpstarting the economy, where is the Federal Reserve to turn?  Certainly, it could continue to purchased fixed-income securities from the US Treasury, but at some point it will be the only buyer.  It could also invest in MBS debt, which would give the US government the ability to refinance the millions of underwater mortgages in this country, but such a move might be unpopular.

Separation of Corporation and State

Now that the Fed has diluted the real interest in Treasuries to a point at which investors would rather sit on their money (and rightfully so!), where can the Fed go next?  Could it adopt a policy from the Freedman book, enacting a buying crusade straight through Treasuries into mortgage-backed securities, then corporate debt and equities?

If monetary policy is the sole tool at Bernanke's disposal, and if it is an asset-buying spree that is the solution to economic slowdown, the resulting program will have to venture into corporate ownership.  Corporate debt yields are still quite high, and corporate equities, based on an earnings yield ratio, are several times more profitable than US-government issued fixed income.

It seems that the Fed, having filled itself to the brim with US Treasuries and failing to jumpstart any asset rally, will have to work more directly to push up asset prices.  Could the Federal Reserve enter into the markets to buy up US corporations indirectly through share purchases?  Legally, it could not, but legally it couldn't lend billions of dollars to hedge funds under the premise of "too big to fail," either.

The point is this:  as economic recession continues on, there will be more calls for direct action by the Fed in the financial markets.  Freedman, who advocated a GDP growth target to spur economic growth following a recession, was sure to point out that you do not stop the printing presses until GDP hits your target, even if that means defying convention.  The next Fed move will be big because it will be the last that Americans allow.

By Dr. Jeff Lewis

    Dr. Jeffrey Lewis, in addition to running a busy medical practice, is the editor of Silver-Coin-Investor.com and Hard-Money-Newsletter-Review.com

    Copyright © 2011 Dr. Jeff Lewis- All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


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