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Impact of Fed's decisions unclear
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Published: April 2, 2009
The Federal Reserve has elevated this financial crisis to an entirely new dimension by announcing several initiatives that would expand its balance sheet by more than $1 trillion.
Effectively, they've decided to fire up the printing presses and create money where there once was none. We've been told that money doesn't grow on trees. Now we know where it really comes from — the stroke of the government's pen.
With the federal funds rate already near zero, the Federal Reserve pulled out the big gun and said they would buy up to $300 billion of Treasury securities. This essentially means one arm of the government is issuing bonds and another arm of the government is buying them. By creating this additional demand for the bonds, the Fed hopes interest rates will drop. So far, it's worked. The yield on 10-year treasuries dropped about one-half of a percent within minutes of the Fed's announcement.
Mortgage rates dropped as well, so if you're looking to buy or refinance, now may be a good time.
The long-term effect of the government buying its own bonds is unknown. Some say it is the right medicine and will help foster an economic recovery by keeping interest rates low. Others say it will lead to a currency crisis and ruinous inflation. Investors reacted by sending hard assets like gold and oil higher, the U.S. dollar lower, and the stock market up for a short period then down the next two days.
The kind of money we're talking about now to fix this mess is almost beyond comprehension. Based on its announced plans, MarketWatch says the Federal Reserve's balance sheet may now grow to more than $4 trillion, up from less than $1 trillion last fall. And Goldman Sachs economist Jan Hatzious says the Fed may ultimately need to expand its balance sheet to a whopping $10 trillion to restore economic growth. Viewed from a different perspective, Morgan Stanley economists estimate that interest rates should be negative 5% in order to restore growth. Of course, you can't have negative interest rates so the government is doing the next best thing — it's using everything in its arsenal to bring them closer to zero all along the yield curve.
These are certainly interesting and challenging times, but together we will get through them and ultimately flourish.
Ted J. DeLisi is investment manager for Sovereign Investment Group in Troutman. Call 704-508-4949 or visit www.sigwm.com.
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