The qualitative Federal Reserve

Recall that the Federal Reserve announced a “quantitative easing” strategy earlier this month.  The idea was to inject $600 billion into the U.S. economy by buying outstanding bonds.  That, in turn, was supposed to create greater liquidity in the economy and drive down the value of the U.S. dollar.  I argued at the time that the primary benefit of the Federal Reserve’s actions was qualitative, not quantitative.  Why?

My opinion was driven primarily by the fact that $600 billion was only slightly more money than was normally injected into the U.S. economy.  Instead, I argued that the action was a signal to the trading partners of the United States that the nation was not going to forever underwrite their export economies by having an overvalued dollar.

The Federal Reserve has, in fact, initiated its “quantitative easing” strategy by buying tens of $billions of U.S. government debt in the open market.  Normally such a huge increase in demand wrought over a fixed supply would result in rising prices of those bonds.  The effect of that is to drive down the yields on those bonds.  But lo, and behold, investors are selling U.S. government debt in such quantities that the value of U.S. government debt is actually falling.  The interest rates, or yields, on those bonds are now at their highest level in more than three months.

In other words, you heard it here first!  Noting the success of my prediction is not very interesting, though.  Instead, let’s consider: why is this happening?

1.  One thought is that some of the affected governments of the U.S. trading partners have been selling their reserves of U.S. government debt in order to compensate for “quantitative easing.”  It is my intuition that this is roughly 65% likely.

2.  Another reason that debt is being sold off could be that investors are gaining more confidence in the U.S. economy.  This would mean that they are selling off the “safe haven” of U.S. government debt where their cash was parked.  However, these monies must be in cash, because if investors were now investing in equities, you would have expected a rise in the equity markets.  And that just hasn’t happened.  So this latter option I consider to be about 35% likely.

Be well everyone!

Jason