The prospect of the end of bond purchases drives stocks down. Speculation continues as to just when the US Federal Reserve will start tapering off its $85 Billion a month purchase of US Treasuries. Recent comments from the Fed indicate that changes in the program could come as soon as next month. As the beginning of the end of bond purchases drives stocks down, bond holders and gold investors assess prospects. The Fed has previously announced that it will reduce the size of its bond purchasing program incrementally as the economy improves. Lower unemployment figures and the lowest trade deficit in four years indicate that changes may come soon.
What Will Happen to Interest Rates?
As the expected end of bond purchases drives stocks down it will likely drive interest rates up. The underlying purpose of the bond purchase stimulus program has been to drive interest rates down and keep them there. As the Fed gives up the job of soaking up all of the Treasury notes interest rates will rise. Fed chairman Bernanke has stated that the Fed will proceed slowly so as not to stifle the recovery. Another issue that has come to the fore is that of possible deflation of the US economy . During periods of deflation cash is king. Deflation makes you richer if you have money in the bank and poorer if you have extensive debt. Inflation raises the money value of homes and businesses over time and the debt taken on to purchase them becomes less of an issue. The reverse happens in deflation when homes and businesses become cheaper in relation to cash and debt can become overwhelming. If deflation occurs it is possible that you will need to pay a small amount of interest to the bank in return for them keeping an eye on your money. That is to say, deflation could lead to negative interest rates. As the possible end of bond purchases drives stocks down it also raises the possibility of deflation and the specter of negative interest rates.
Gold Will Become Less Attractive
The Federal Reserve and the nation are fortunate that the world expert on the root causes of the Great Depression took the helm of the Federal Reserve during the worst financial crisis in three quarters of a century. The take home lesson from fundamental analysis of the early 1930’s is that you need to stimulate the economy at times of economic contraction or risk having things get worse. As luck would have it Mr. Bernanke did exactly that and helped the nation avoid a second Great Depression. The stimulus bond program is part of the rescue package for the US economy. However, financial stimulus programs need to come to an end or they threaten to bankrupt the US government by loading on ever-increasing debt. As the end of bond purchases drives stocks down it will also lead to a further fall in gold prices. One is that gold tends to fall when interest rates go up, which will likely happen as the stimulus programs ends. Also, by reducing government spending the nation will more likely come to grips with its debt burden which will lead to fewer folks squirreling away gold as protection against financial collapse. If investing in gold interests you, you may want to wait until the fall is over and there is a bounce.