December 12, 2012
For the past two days, the indices have climbed on the hope that the Fed will reveal a new Treasury bond-buying program to replace Operation Twist, which is due to expire this month. In an effort to shore up the financial markets and spur jobs growth, the Fed has instated three rounds of Quantitative Easing over the past four years.
And as of this afternoon, the Fed has pledged to continue this trend. For the foreseeable future, the Fed is going to continue to buy $45 billion a month in long-term Treasuries as well as $40 billion a month in mortgage-backed securities. As to be expected, investors celebrated the move and pushed the indices higher during afternoon trading.
But with borrowing costs already at a record low for consumers and home buyers, economists are divided on whether another round of stimulus measures will profoundly affect the economy.
One this is for sure: The Fed's dovish policies have pushed interest rates near zero and will keep them at this ultra-low level for some time to come—specifically until the unemployment rate falls to 6.5%. And this will help ensure that the stock market remains more attractive that the bond buying market. The S&P 500 currently yields an average of 2.2% while economists expect the yield for 10-year Treasurys to drop as low as 1.4%.
The other upside to a low interest rate environment is that it affects mortgage rates, making home buying more attractive for prospective buyers. As I've mentioned before, the housing market is having an outsized impact on the economic recovery so anything that will encourage more consumers to consider buying a new home will be a plus.
Of course, now that the Fed has committed to another round of bond buying, the dollar should remain weak relative to many international currencies. Because a weak dollar makes U.S. exports cheaper and imports pricier, this should also keep the U.S. trade deficit in check. Just yesterday, the Commerce Department announced that the trade gap widened to $42.2 billion in October due to a 3.6% drop in exports—the largest such drop in nearly four years. In theory, the Fed's stimulus should prevent drops like these in the future.
So as with any big policy move, there are upsides and downsides. Time will tell how the artificially low interest rates will impact things like employment, home sales or the dollar. In the meantime, the Fed's announcement has injected some much-needed optimism into the markets today and I'll gladly accept the diversion from the fiscal cliff drama.