Federal Reserve Chairman, Ben Bernanke, just announced that the Fed will embark on yet another round of ‘quantitative easing’. Let’s call this round QE-Unknown. It’s unknown because he set no end date for the program and indicated that the Fed would purchase about $40 billion of mortgaged-backed securities on a monthly basis until such time as they, the Fed, sees what they refer to as ‘substantial improvement in the labor market’. When asked how he would define ‘substantial improvement’, he responded, “We haven’t come to a set of numbers, but we’re guaranteeing that we won’t tighten too soon”.
Most people’s eyes glaze over when you talk about quantitative easing because they have no idea what that means. In its simplest terms these massive mortgage-backed securities purchases are the equivalent of the federal government starting up the printing presses and printing more dollar bills. Now in actuality, this is all done electronically but the effect is the same… a greater supply and devaluation of U.S. dollars. You’ll likely feel it at the gas pump and in the grocery store if the form of higher prices.
Who are the winners and losers of this strategy?
Stock market investors will, I think, be the winners because the flood of money guarantees the continuance of low interest rates which businesses can tap into to drive growth should they choose to do so. New home buyers will also benefit from historically low mortgage rates.
The real losers are savers, especially retirees, who depend on interest income from fixed investments such as bank CDs, money market accounts and bonds. In 2006, we were earning over 4% on money market accounts while today you can only get a fraction of one percent. In 2006, the 10-year Treasury bond yield was over 5% while today it stands just over 1.8%. This is a near-impossible situation for retirees but is a problem that will likely persist for several years.
Will quantitative easing do the job this time?
One of the Fed’s primary stated goals is to reduce unemployment. Unemployment, however, has remained above 8% for more than 40 months including the first two Quantitative Easing programs dubbed QE1 and QE2. One has to wonder if continuing to force low interest rates will actually stimulate re-employment. It seems that most people have already refinanced their mortgages and current low mortgage rates are not stopping potential new buyers from purchasing a home. Likewise, if the current low interest rate environment has not substantially stimulated businesses to hire new employees, I’m not sure how this latest round of new money printing will change the current trajectory. While I have my doubts this this latest QE-Unknown will be successful, like every other American, I remain hopeful.
How can you benefit from the Fed’s latest move?
1. Invest in stocks. As I mentioned earlier, stocks should benefit from the ballooning money supply. Retirees will also want to consider shifting some assets to stocks, especially U.S. blue chip dividend-payers. You can receive a significantly higher yield than on bonds and CDs and potentially benefit from rising stock prices. Be sure to keep a minimum of four to five years’ worth of cash flow needs in high quality bonds, CDs or money market accounts.
2. Bonds may benefit. To the extent that QE-Unknown drives interest rates down from their present levels, bond values will rise.
3. Refinance or buy a new home. If you have not refinanced your home mortgage in the last twenty-four months you should check out the potential benefit of refinancing. If you don’t own a home, there may be no better opportunity than right now.
In all cases, you must watch future actions of the Federal Reserve closely. What will happen when this round of quantitative easing ends? Maybe it was just coincidence but when QE2 ended on June 30, 2011 the stock market dropped 15% by August of that same year.
If you have a financial question you’d like me to answer in The Birmingham News, email me at [email protected] and place Bhm News in the subject line. Consult your own professional legal, tax or financial advisor before acting upon this advice.
Mark your calendars for the Financial Planning Association of North Alabama’s free symposium to be held on Tuesday, October 2nd. I’ll give full details in next week’s column.