Archive for the ‘Interest Rates’ Category

This Is Progress?

Friday, September 28th, 2012

Economic growth for the second quarter of 2012 officially has been revised down to 1.25%, which is below the lowest previous estimate.

In an effort to stimulate the economy, the Obama Administration and the U.S. Congress have added $6 trillion to the federal debt, with annual deficits exceeding $1 trillion.  The Federal Reserve Board meanwhile has announced its third round of quantitative easing, on top of Operation Twist.

Yet the unemployment rate remains over 8% and, as we stated earlier this month, could be as high as 19% if you take a true and accurate count of everyone who is not working.

Since the current “recovery” began, real income for the average American has dropped 5.7%, and while inflation as a whole remains in check, the price of essentials such as oil and food has soared.  At least we can credit quantitative easing with taming deflation!

This all sounds pretty gloomy, but cheer up.  Alan Krueger, who chairs the President’s Council of Economic Advisors, says “we’re making progress.”

It’s All Relative

Progress, of course, is relative.  It’s true that the free fall that began in 2008 created the worst economic conditions we’ve encountered since The Great Depression, but in the past the rule has been the greater the recession, the greater the recovery.

Not so this time.  Cumulative growth for the past three years has been just 6.7%, according to the Congressional Joint Economic Committee.  In comparison, the average for all 10 post-World War II recoveries is 15.2%.

In other words, the economic growth we’re experiencing is well under half of what it has been historically after past recessions, even though it should have been among the best periods of growth ever, given the severity of the recession.

Worse still, we can look forward to the long-term impact of today’s failed economic programs.  Someday, the debt we’ve accumulated will have to be paid back.  And quantitative easing may keep the country’s debt payments manageable today, but it weakens the dollar and boosts inflation.

And sooner or later interest rates could rise to the point where our current tax revenues will not be enough to pay the interest on our debt, let alone support government programs.

So what do we do when the current economic programs produce the same results as they have in the past?  Prepare for a multi-trillion dollar stimulus package?  QE3, the third quantitative easing program is open ended and can last as long as The Fed wants it to last, so at least we don’t have to worry about QE4.

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Posted in Deficit, Inflation, Interest Rates, The Economy, U.S. Debt | No Comments »

Over Fed

Friday, July 20th, 2012

To QE3 or not to QE3?  That is the question the Federal Reserve Board has been pondering for months … or at least Fed observers think it’s being pondered.

But, as we’ve said before, if the first two rounds of quantitative easing did little to boost the economy, why would a third round help?  In fact, each successive round of Fed action has had less of an impact than the one before it.

Quantitative easing is the printing of money by the government to buy bonds, which is supposed to stimulate consumer spending.  It hasn’t worked, because consumers are still broke and many have maxed out their credit cards.

The Fed also tried Operation Twist, which involved selling short-term bonds and using the funds to buy longer-term bonds, also had little impact.  Operation Twist, which might have been called QE 2½, was supposed to lower long-term interest rates to stimulate borrowing and investment, but it also has had little impact.

As Frank Barbera of Sierra Investment Management put it in his white paper, “Reflections on Slowing Global Growth,” “most of the liquidity created by QE1 and 2 did not find its way into the real economy, but instead ended up right back on the books of banks as excess reserves, with banks actually contracting their loan portfolios.”

Helping banks build excess reserves was, of course, not the goal of QE 1 and 2.

The one positive aspect of quantitative easing is that each round gives the stock market a temporary boost, but the impact is like that of chocolate, which creates a temporary boost, but makes the consumer more lethargic afterward.

Ray Dalio of Bridgewater Securities expressed concern that “there are no more tools in the tool kit of fiscal and monetary policy to help kick the can down the road.”

The problem with kicking the can down the road is that, at some point, the road ends.

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Posted in Bonds, Interest Rates, Quantitative Easing, The Federal Reserve Board | No Comments »

Dancing With A Cow

Tuesday, July 17th, 2012

While Europe’s sovereign debt crisis has beaten down the U.S. stock market, it has helped the bond market.

Because the European bond market is in such poor shape, U.S. bonds are a relatively healthy investment.  Investors have been buying U.S. bonds, because they look good relative to European debt.  But that’s like dancing with a cow because your only other option is a pig.

U.S. yields are at record lows, even though U.S. debt has now reached $15.9 trillion, up from $9 trillion in 2007.  The 10-year Treasury yield, which has averaged 4.88% over the past two decades, hit a record low of 1.44% on June 1, down from its high for the year of 2.4% percent on March 20.

Regardless, the cow may be turning into a pig.  Robert Auwaerter, head of Vanguard Group’s fixed-income group, predicted that unless the U.S. gets its debt under control within the next four years, U.S. bonds will become about as popular as the bonds of the five European countries that have seen borrowing costs soar as investors boycotted their bonds.

What Bloomberg called a Treasuries Doomsday isn’t on the Mayan calendar, but it could be as grim as those end-of-days predictions, at least from a financial perspective.  If yields were to rise back to 3.8% by December 2014, which is their average for the past decade, investors would realize loses of 10.8%.

Demand for U.S. bonds has enabled the Federal Reserve Board to keep borrowing costs low, and President Obama and Congress to fund a budget deficit that’s forecast to exceed $1 trillion for the fourth straight year.

However, Auwaerter said, “In the absence of a long-term credible plan, we are somewhere around four years away on where the markets are going to say ‘enough is enough.’ ”

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Posted in Bonds, Interest Rates, President Obama, Sovereign Debt, The Economy, The Federal Reserve Board, U.S. Debt | No Comments »

Bad News Boosts the Market

Tuesday, June 12th, 2012

In the strange world of investment management, bad news is often good news.

That was the case last week, as the S&P 500 gained a hefty 3.7%, more than reversing its 3% loss from the previous week.

The market rose 2.3% on Wednesday alone – its largest single-session percentage gain so far this year – amid signs that the already tepid economic recovery is slowing further.

So why did the market rally?  Because traders speculated that the Federal Reserve will react to the slowing economy with additional stimulus.

Fed Chairman Ben Bernanke didn’t even hint at any immediate plans for a third round of quantitative easing or any other steps to stimulate the economy.  The European Central Bank (ECB), likewise, left its benchmark interest rate at 1.00%.  However, ECB President Mario Draghi said that actions would be taken if needed.

So the chance that another round of stimulus may take place is enough to boost the market 3%.

S&P 500 Chart

Given that economic growth remains anemic and the unemployment rate is at 8.3% and is generally creeping up, not down, previous rounds of stimulus have had virtually no long-term impact.

Short-term, though, markets love quantitative easing, which makes investments in stocks appear desirable by making investments in other assets undesirable.

So if quantitative easing doesn’t help the economy and provides only a short-term boost to stock prices, maybe the Fed should just float a few rumors … plan a faux round of quantitative easing to give the markets a boost without any cost or harm to the economy.

The Pain in Spain, Part 2

 Spain added to the good-bad news last week, as Fitch downgraded Spain’s debt rating from A to BBB after the country held a successful debt auction.

A teleconference last week between G-7 finance ministers to discuss Spain’s banking system, along with other Eurozone problems, failed to yield any specific plan for addressing the crises, and Fitch followed up yesterday by dropping ratings on two major Spanish banks, Banco Santander S.A. (STD, SAN.MC) and Banco Bilbao Vizcaya Argentaria S.A. (BBVA, BBVA.MC).

The downgrades, from A to BBB, came in spite of a weekend agreement by the Spanish government to a European Union bailout of up to EUR100 billion, or about $125 billion.

Spain joins Greece, Portugal and Ireland in the growing list of bailees.  Soccer anyone?

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Posted in Interest Rates, Personal Finance, Quantitative Easing, S&P 500, Sovereign Debt, Stock Market, The Economy, The Federal Reserve Board | No Comments »

Housing Market Needs Rehab

Friday, May 27th, 2011

It wasn’t long ago that housing seemed like the best possible investment.  Housing prices just kept going up, up, up.

Now 2011 is on track to become the sixth consecutive year of declines in new home sales and, as a consequence, prices are going down, down, down.  Unless the housing market rebounds, which appears unlikely, 2011 will see the fewest homes sold on record (records have been kept since 1963).

The Wall Street Journal notes that “The 323,000 new homes sold in 2010 was less than 60% of the number of new homes sold in 1963, even though the
population today is nearly two-thirds bigger.”

Even with interest rates at historically low rates for the past couple of years, the market has continued to decline.

Even more discouraging, The Journal notes that housing has increasingly been tied to economic cycles.

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Posted in Housing, Interest Rates, Stock Market, The Economy | 1 Comment »

Pick One: High Risk or Low Returns

Monday, May 2nd, 2011

Here’s your choice: Take on lots of risk and hope for the best or watch your standard of living erode.

The stock market has been soaring, thanks to the Federal Reserve Board’s quantitative easing program, which has continued to hold interest rates at or near record lows for several years now.

Investors came back into the market, not because the market was showing signs of strength, but because it became the least objectionable place for investors to put their money.

A 12-month certificate of deposit (CD) is yielding 1.25% interest today.  The U.S. inflation rate rose to 2.7% in March and is continuing to rise – a deliberate outcome of Fed policy.  So the real rate of return, in exchange for tying up your money for a year, is negative 1.45% (2.7% – 1.25%).

Conversely, The Russell 2000 Index of small-cap stocks recently hit a new high, having jumped 150% since March 2009, including a 9.5% gain so far for 2011.

Small-cap stocks are, of course, the riskiest stocks, representing companies with market capitalizations of $2 billion or less.  And the higher small-cap prices soar, the riskier they become and the more likely it will be that we will see a market correction.

What will happen when quantitative easing ends?  What will happen when market conditions, rather than Fed programs, dictate returns?

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