The most recent employment report was good and the market is worried. Will there be a fast or slow demise of quantitative easing by the Federal Reserve? Basically the market is worried that in response to an improving economy the US Federal Reserve will stop buying US Treasury Bonds. This prospect has already driven interest rates higher. The chairman of the Fed, Mr. Bernanke, has promised a slow demise of quantitative easing based on the rate of improvement in the economy. Nevertheless, the market, which discounts information as soon as it is available, is concerned that a too-rapid cessation of the Fed stimulus program will
1) send the economy back into recession,
2) or drive gold prices down,
3) or drive oil down in the US and higher elsewhere,
4) or drive the dollar higher.
To start fundamental analysis of the prospect of a fast versus a slow demise of quantitative easing let us start with just quantitative easing really is.
Quantitative Easing
When the worst recession in three quarters of a century occurred luck would have it that Ben Bernanke was already the chairman of the US Federal Reserve. Mr. Bernanke is probably the world’s greatest expert on the causes of the Great Depression. The short answer to why the Great Depression occurred is that the government of the USA tightened credit when it should have eased it, started a trade war, and failed to find ways to stimulate the economy. When confronted with a possible re-run of the Great Depression on a much worse scale the US Federal Reserve and then other central banks initiated Quantitative Easing. This policy involves buying financial assets from commercial banks and other private institutions which in turn increases the monetary base. In addition, the Fed has been buying $85 Billion in treasury bills each month. This has driven interest rates down, soaked up the bond supply, and sent bond investors into the commercial bond market for investments. Quantitative easing has reduced interest rates and increased the value of pre-existing bonds. The general consensus is that Quantitative Easing has helped the US economy, and the world, avoid another Great Depression. But, now the prospect of a slow demise of quantitative easing has markets concerned. Now what do sound stock investing principles say about the slow demise of quantitative easing?
Interest Rates Are Going Up
As the need for the Fed to perpetually dump money into the US economy fades away and bond purchases diminish, interest rates will go up. Bond investors are already dumping low yield bonds and holding cash while they wait to re-invest at higher rates.
The Dollar Is Rising
Higher US interest rates drive up the value of the US dollar in the Forex market. This reduces the cost of foreign goods as well as foreign investments. One may consider investing in foreign stocks as they become cheaper. You may wish to take a look at our article about three good offshore investment ideas .
Increased Import and the Long Term
Gold is heading downhill as interest rates rise. However, a stronger dollar will likely attract more imports and continue to erode the US balance of payments. True gold bugs do not speculate on the short term rise and fall in gold prices but rather on the slow and steady rise of gold against a steadily devalued dollar. Over the long term the slow demise of quantitative easing could bring gold and make it profitable to invest in gold as it bottoms out in the near future.