One of the biggest news items up for debate is the Fedâ€™s expected announcement of another round of Quantitative Easing (QE2) when it releases its statement this week. Remember, QE is the concept of the Fed becoming a heavy buyer of Treasuries and Bonds. This is done to artificially cause those security prices to move higher under the increased demand, which in turn will cause interest rates to move lower in the hopes of stimulating the economy – but it also continues to load the US with debt and may have numerous other negative unintended consequences. Although this move by the Fed is likely, itâ€™s been under some criticism – and after hearing some colorful commentary about QE2 last week from Fed Chair Ben Bernanke, the skepticism heightened.
Fed Chair Bernanke compared the Fedâ€™s handling of the next round of QE2 to being like a golfer with a new putter , stating that the golfer has to tap lightly at first and try to figure out how to use it properly. Wow – not exactly words that inspire confidence in the Fedâ€™s ability to get QE2 right… particularly when you consider that the weekend golfer has a less than 50% chance of sinking a putt 3 feet in length .
And one of the Fed members themselves, Kansas City Fed President Thomas Hoenig, actually said that attempting to stoke change for the economy via monetary policy like QE2 is making a “bargain with the devil”. Strong words .
Bill Gross, manager of the world’s largest Bond fund, PIMCO, took the criticism of QE2 a step further. He recently stated that “Checkwriting in the Trillions is not a Bondholderâ€™s friend… it is in fact inflationary, and, if truth be told, somewhat of a Ponzi Scheme . It raises Bond prices to create the illusion of high annual returns, but ultimately it reaches a dead end where those prices can no longer go up.” Definitely colorful language, likening what is happening to a “Ponzi Scheme !”
While Bill Gross doesnâ€™t always get it right… he sure has it right here. Printing more money will ultimately be a negative to Bond investors, and could pose serious negative consequences to the economy down the road .
Letâ€™s take a look at one of the consequences that may impact consumers looking to purchase or refinance a home in the future.
For months there has been an ever-growing fear that our economy is headed towards deflation, which is when prices on goods and services are falling lower. Deflation is the exact opposite of inflation, which of course occurs when prices climb higher. Remember, inflation is the arch-enemy of Bonds, so fears of inflation negatively impact Bond prices and home loan rates. But fears of deflation are good for Bonds and home loan rates. Thatâ€™s because the fixed payment that a Bond provides to an investor goes further in a deflationary environment. So, the recent fears of deflation have helped Bond prices move higher and home loan rates move lower.
But last week, future deflation/inflation expectations changed… and investors in the Bond market started betting that the Fed will be successful in “creating inflation” via their Quantitative Easing plans, and will thus avoid continuing down a deflationary road . This was evidenced by the results of last weekâ€™s 5-Year Treasury Inflation Protected Securities (TIPS) auction, which saw investors buying TIPS at a premium since they were confident theyâ€™d be able to benefit from the increased inflation that should result from the QE2.
Of course, investors arenâ€™t the only ones impacted by this. The media has already been chattering that the Fed has to be careful not to let inflation get out of control in the coming months and years. In fact, just last week, there was a headline explaining how another round of Quantitative Easing brings the risk of “unleashing the 1970s inflation genie.” Consumers who are looking to purchase or refinance a house should also take note of that possibility – since even talk of inflation can impact home loan rates negatively. After all, a rise in inflation would be bad for Mortgage Bonds and, as a result, for home loan rates.
The good news is that home loan rates are still near historic lows for the time being. If you or someone you know would like to see how you can benefit from the current situation, call or email me today .