The Federal Reserve Board has made its long-awaited announcement that it will begin to scale back ("taper," in WallStreetSpeak) its QE3 stimulus program. The last time the Fed even mentioned starting to taper back, last fall, global stock markets and bond investors panicked and sent the markets reeling. Now, the Fed says that instead of buying $85 billion in Treasuries and mortgage bonds per month, it will only buy $75 billion, and more cuts will come as the economy continues its recovery and the jobless rate continues to fall.
With this announcement, markets went up and investors cheered. Japan's Nikkei index reached a six-year high, European markets soared, and U.S. stocks finished the day at new record prices.
Does any of this make sense to you?
The so-called "taper," and the QE3 stimulus program itself, are somewhat unique in the history of investment markets. To understand QE3, imagine that at the auctions where investors buy government bonds and packages of home loans, a bidder nine times the size of Gargantua shoulders everybody else aside and insists on paying higher prices (and, therefore, receiving lower interest) than any of the other bidders. The Feds' stated goal was to stimulate the economy by driving interest rates lower, making it less expensive for large and small businesses to borrow money, so they can build factories, expand their capacity and hire more people.
The problem with this stimulus effort all along was that American corporations are already sitting on tons of cash, and have little need to borrow if they really want to go on a building and hiring spree. The companies in the S&P 500 index reportedly have a record $1.5 trillion in their coffers, up 14% this year alone. Add in the money stuffed under the mattresses of smaller companies, and the total may exceed $5 trillion.
The Feds' mortgage purchases probably did make mortgage rates a bit cheaper for home buyers, but it's hard to tell how much. The day after the announcement, 30-year Fannie Mae mortgage rates were up 0.01 percentage points, at 4.42%. That's higher than the low of 3.31% in November of 2012, but still very low by historical standards.
Savers and long-term investors should breathe a sigh of relief that the Fed is finally easing out of the investment business. Why? For one thing, it means that economists at the Federal Reserve Board believe the economy is finally in a self-sustaining recovery mode.
For another, it means the end of uncertainty. When investors are unsure what to expect, they tend to expect the worst, which is why you will read articles saying that the taper will cause interest rates to skyrocket out of control, leading to all sorts of bad things in the economy, possibly including an alien invasion. By the (admittedly early) indications, no such thing is happening, and you can bet that Fed economists are monitoring the situation and plan to nip any catastrophe in the bud.
But at the same time, we can expect interest rates to go up over the next year or two at least, which is great news for older Americans who have been living on a fixed income with CD rates barely higher than what they would get if they stashed their retirement money in a cookie jar.
For the economy as a whole, there is still plenty of cash to lend to any company that wants it, housing is still more affordable than it was before the 2008 meltdown, and inflation is actually (and stubbornly) lower than the government's preferred target rate. Investors were wrong to panic last fall, and they are right to cheer now as the biggest, clumsiest bond buyer in history starts cautiously easing away from the auction table.
Sources:
http://www.cnbc.com/id/49519419
http://www.cnbc.com/id/101279385
http://www.foxbusiness.com/personal-finance/2013/12/18/how-fed-taper-announcement-could-impact-your-finances/
http://www.bloomberg.com/news/2013-12-18/mortgage-bond-yields-little-changed-after-fed-taper-announcement.html
http://money.cnn.com/2013/12/18/investing/world-markets-thursday/
http://money.cnn.com/2013/12/18/news/economy/federal-reserve-taper/
Sincerely,
William T. Morrissey and Tammy Prouty
Sound Financial Planning Inc.
wtmorrissey@soundfinancialplanning.net
Primary Office
425 Commercial Street, Suite 203
Mount Vernon, WA 98273
Phone: (360) 336-6527
Secondary Office
650 Mullis St., Suite 101
Friday Harbor, WA 98250
(360) 378-3022
PLEASE READ THIS WARNING: All e-mail sent to or from this address will be received or otherwise recorded by the Sound Financial Planning, Inc. corporate e-mail system and is subject to archival, monitoring and/or review, by and/or disclosure to, someone other than the recipient. This message is intended only for the use of the person(s) ("intended recipient") to whom it is addressed. It may contain information that is privileged and confidential. If you are not the intended recipient, please contact the sender as soon as possible and delete the message without reading it or making a copy. Any dissemination, distribution, copying, or other use of this message or any of its content by any person other than the intended recipient is strictly prohibited. Sound Financial Planning, Inc. has taken precautions to screen this message for viruses, but we cannot guarantee that it is virus free nor are we responsible for any damage that may be caused by this message. Sound Financial Planning, Inc. only transacts business in states where it is properly registered or notice filed, or excluded or exempted from registration requirements. Follow-up and individualized responses that involve either the effecting or attempting to effect transactions in securities or the rendering of personalized investment advice for compensation, as the case may be, will not be made absent compliance with state investment adviser and investment adviser representative registration requirements, or an applicable exemption or exclusion. This information should not be construed as investment advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. WE WOULD LIKE TO CREDIT THIS ARTICLE'S CONTENT TO BOB VERES.
