Fed action may hurt more than help
The Federal Open Market Committee, which meets Nov. 2-3, is all but certain to announce renewed measures intended to boost the economy. Specifically, the Fed will engage in another round of bond-buying, snapping up government debt with newly created money. It is hardly a secret this is coming; for those of you too consumed by “Dancing with the Stars,” Bernanke and his colleagues have been telegraphing it for months. The only question is the magnitude of the effort — how much and over what period of time?
The Fed’s goal is that this step will further reduce interest rates and create incentive to borrow, spend and energize economic recovery. But much of the effects have already been priced in, with the 10-year Treasury yield falling from 3 percent in late July to 2.41 percent by early October. In recent days, investors have been tempering their expectations in the event the Fed takes a more cautious approach, with the 10-year Treasury yield having backed up from 2.5 percent on Oct. 19 to 2.75 percent as of Oct. 27.
So will it work?
This latest go-round won’t single-handedly revive the economy any more than the previous version did. And it may not even serve to drive rates lower like the earlier $1.75 trillion government and mortgage-backed debt program did, particularly if the size of the Fed’s efforts are deemed to be too modest.
Perhaps the best case is that it keeps a lid on rates, but if so, it won’t do much more than serve as a symbolic gesture that “at least the Fed did something.” Whether the Fed successfully drives rates lower or just keeps them from rising, this doesn’t have the makings of a surge in economic activity. Know any borrowers holding out because rates just aren’t low enough?
You might wonder why even bother with it at all. Several years prior to becoming Fed Chairman, Ben Bernanke had scolded the Japanese on their lackadaisical approach to their own deflationary episode. So now Bernanke has to put his money — make that our money — where his mouth is.
All this could do more harm than good if it fuels expectations of higher inflation down the road, resulting in a rise in long-term interest rates rather than a decline. Inflation hurts long-term rates the most, and the express goal of the Fed is to create some inflation as a way to avoid deflation.
This also hurts savers in two ways. It keeps rates on income-producing investments such as money markets, savings accounts, certificates of deposit and bonds at ultra-low levels for some time to come. And if inflation is the end result, who does that hurt the most? Those very fixed income investors.
In an effort to boost the economy, the Fed is poised to take a step that has questionable effectiveness. It continues to throw savers under the bus and poses a risk of future inflation that hurts everyone, but savers disproportionately.