CASH FLOW MANAGEMENT
ECONOMIC & MARKET INSIGHTS
Economics 101 Watching the Paint Dry at the Federal Reserve By Scott M. Colbert, CFA ®
“Federal Reserve-speak” is a language that remains a mystery to many Americans and we have an army of analysts that attempt to interpret Federal Reserve Chair Janet Yellen’s every utterance on economic policy. Yellen said earlier this month that the Federal Reserve (Fed) is now starting to focus on undoing the “Quantitative Easing” that occurred after the Great Recession by shrinking its balance sheet. It’s worth stepping back for a moment to explain this concept and how it’s likely to affect investors and borrowers alike. This country was in uncharted territory when the Fed went on a bond buying spree from late 2008 to 2014 as it purchased nearly $3.5 trillion of government securities to initially help shore up our sinking economy, lower longer-term interest rates and eventually propel a feeble recovery forward. And now that the economy is relatively healthy, the Fed believes it would be good practice to offload some of those bonds tucked furtively away on its balance sheet and give them back to the world’s financial markets. If they do it right, according to Yellen, it should be like “watching paint dry.” What does this really mean? When the economy went into a financial tailspin in 2008, our Federal Reserve Bank reacted first by pushing short-term interest rates quickly to zero. But they were (rightfully we think) worried that this might not provide enough thrust to bring us back to a level flight path. They wanted to lower longer-term interest rates as well. So they began this Quantitative Easing program, otherwise known as QE. In three rather massive waves over six years, the Fed began purchasing both Treasury bonds and U.S. government-guaranteed mortgage-backed securities primarily for two reasons. First, they believed this new, additional demand for bonds was likely to help lower longer-term rates (and it likely did). In addition, since the Fed in effect “created” the money to buy these bonds, it would also boost the money supply as the proceeds from its purchases flowed to whatever financial institution sold them the bonds. And, in turn, that new money would hopefully be providing fresh capital to the banking system and be put back to work buying other assets (driving those values higher), or providing fuel for lenders to make new loans. In essence, this additional liquidity might help businesses or consumers who were still gasping for monetary oxygen.
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