QE and Low Interest Rates - End Game Planning

by Lear Capital EditorialJune 20, 2013
tunnel of money

Will it or will it not? The big question on the Fed’s next move regarding Quantitative Easing is … will it end. The Government’s monthly, mass money infusion into the markets have clearly kept them riding high, but is the end now in sight? And what does that mean for investors?

With an unofficial “hem” and a classic “haw” Fed Chairman Bernanke indicated his intention to end the “Big Ease” implying that tapering could start within months and that he would like to close the chapter on Federal bond buying by mid-next year. But, will there be a happy ending? The mere whisper of a still wobbly economy suddenly losing its training wheels causes the Dow to tumble more than 200 points. And despite the government holding the federal fund rate steady for now, mortgage rates have already risen, surpassing 4% for a 30-Year fixed loan for the first time in a year.

In addition to ending QE, the Fed will have to address its short-term interest rate which most experts agree must rise in order to combat our mounting debt and rising deficits. The increase in interest rates has historical relevance. The current federal fund rate target is 0% to .25%. In the past 45 years, federal fund rates have risen from 1.75% in 1965 to a peak of 15% in 1980, and then back down to today’s unprecedented lows. A historic bull market has been rumbling right alongside low rates. The Dow has risen over 6000 points since the start of Quantitative Easing back in 2008. As a matter of fact, 2008 saw three of the largest one-day point gains in history with the markets gaining 936 points on 10/13, 889 points on 10/28, and 553 points on 11/13.

But what about when rates go back up? Does the bull’s run stop? The current near-zero rate policy has been one of the key drivers of profit and returns on CD’s, Stocks and Bonds. Unfortunately, the markets have become somewhat dependent on QE and low, federal rates. With the feds still buying $85 billion in bonds per month and a plethora of cheap money still available to lenders, investors and consumers … it’s hard to imagine that there won’t be a massive profit and loss correction when it all stops.

An increase in rates generally translates to lower markets and rising bond yields. In addition, a federal sell off or unloading of its massive bond holdings could wreak even greater havoc on market prices. So, when rates rise, look for the markets to soften and most paper assets to stumble. And, unless we can maintain economic expansion there could be even greater fallout from the withdrawal of years of federal intervention. The degree to which we can maintain the recovery under the current restraints of our massive debt is what worries most economists.

While the Fed sees an improving economy getting strong enough to soon stand unaided, investors may see something else … that the concept of walking without a safety net after half a decade of tethers and lifelines is plain scary. With all other factors aside, the lack of market confidence alone is enough to send Wall Street into a tailspin.

It’s simply counterintuitive to think that the weaning of QE and the rising of interest rates will not elicit apprehension, agitation, and in some investment sectors downright panic. Now more than ever it’s important to hold a healthy asset mix to neutralize the known negative factors and to reduce the impact of the impending sea-change that awaits the US economy.

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