Fed Chairman Ben Bernanke declared another round of quantitative easing last Thursday. Immediately after announcing that the Fed would purchase $40 billion of mortgage-backed securities per month, for an indeterminate period, stocks soared. Buying mortgage-backed issues will help keep mortgage rates low, which presumably, should strengthen a struggling housing market.
That's the plan anyway. And it may well work if banks cooperate. Remember, there are an estimated five million homeowners who are under water with their mortgages and banks are still a bit gun-shy after the last government-mandated effort, namely, the Community Reinvestment Act. Still, you can't fight the Fed. The Bernanke put is alive and well!
The Fed has been the primary purchaser of government debt for some time now. Hence, I find it interesting that they do not intend to buy Treasuries. Perhaps doing so might encourage additional spending, not that Congress necessarily needs any encouragement.
This recent announcement comes in the wake of Bernanke's persistent declaration that Congress needs to rein in spending. Now the U.S. government must rely on entities other than the Fed to buy its debt. And this is where the story could get interesting. If global demand for U.S. debt weakens, interest rates would rise, and with it, our cost of borrowing and servicing our massive $16 trillion debt obligation. A period of rising stock prices has already put upward pressure on interest rates, as money would flow out of Treasuries. All this is bad news for our debt management.
On the flip side, as those who have studied financial repression well know, low interest rates and moderate inflation is precisely what the government needs to lessen the burden and escape its debt trap. I suppose you could say that an awful lot hinges on future debt auctions. And if the U.S. receives another rating downgrade, as has been speculated, it could get dicey. I suppose as long as the world continues to buy our debt, rates will remain low. Are we still the best house in a bad neighborhood? We'll see.
It's always difficult to prognosticate the future of the financial markets. However, I think it's safe to say that rates will remain relatively low, the global economy will continue to slow, and emerging market central bankers will likely move to reduce their interest rates to stimulate economic growth. That said, EM debt will do quite well in an environment of rate reductions. Moreover, EM stock may be a good bet too, although it's a bit riskier. Large domestic stocks should also trend up with Bernanke's recent decision. You see, typically, when QE is implemented, stocks advance. At least this has been the case with Japan and in the U.S. to date. Commodities could also benefit, but a global slowdown is a headwind to this asset class.
Have a great week!