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Sea Change at the Fed..??
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Posted 11/14/2012 00:17 (#2696145 - in reply to #2694891)
Subject: Re: Sea Change at the Fed..??

The Fed has not changed course since the election. The declines in the stock market reflect the disappointment over Romney losing the election. Romney was perceived by the markets to be more "business friendly". The markets are now discounting the expectation that the President will move forward with more regulation, higher tax rates, ect. Whether this expectation proves to be correct is yet to be determined. Frankly, we have to see what the facts turn out to be.

Unemployment is too high. I think everyone would agree on that point. The Fed has a dual mandate, unlike the ECB, and that is to keep inflation low and employment high. Most would also agree that these are mutually exclusive goals. So what options are available to the Fed in a world where they have taken short rates to zero? Frankly, not many. QE 1 was all about trying to lower interest rates across the yield curve. QE 2, aka Operation Twist, is about trying to change the shape of the yield curve. Selling short debt instruments to buy longer duration debt instruments, primarily Treasuries. These operations will continue until the end of the year. Finally, QE 3 is about buying long term mortgage backed securities issued by the Government agencies in the approximate amount of 40 billion dollars per month. The purpose is to stimulate the housing market by making it so cheap for a borrower to get financing that housing demand is stimulated. Frankly, it appears to be working as housing prices appear to be stabilizing, if not increasing off of their lows. The Fed believes that by stimulating housing, people will feel wealthier and spend more money, jobs will be created and economic activity will rebound. Housing stocks have been some of the best performers this year for those investors that had the guts to buy them.

Bottom line is that the Fed believes the economy needs to be stimulated in order to spur faster growth which should lead to more job creation. The Fed will allow inflation to rise above the presumed inflation target of 2 to 2 1/2% as measured by the GDP price deflator index in order to accomplish faster growth IMHO. The Fed has lots of experience in wringing inflation out of the economy. They simply raise interest rates at the short end of the yield curve and kill demand and slow economic activity, aka, a recession. The Fed has little experience in dealing with deflation. Given a choice between inflation vs. deflation, I suspect the Fed would rather go to war against inflation because they have a better grasp on how the economy would react.

P.S. If you have any long term debt or anticipate acquiring long term debt, now is the time to lock up long term fixed rates.
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