Tags: More Fed Easing Boils Down to Mind over Markets

More Fed Easing Boils Down to Mind over Markets

Friday, 24 Sep 2010 01:48 PM

Wall Street is eagerly anticipating another round of easing measures from the Federal Reserve, but the most visible results of new Fed action could materialize in investors' minds; not their pockets.

Economists are expecting the Fed to start buying Treasuries again, possibly as early as November, to try to further stimulate financial markets and the economy.

But with Treasury yields already hovering around historic lows, analysts say more Fed buying won't be a game-changer for the market. As with many aspects of monetary policy, this new easing program will rely heavily on appearances.

"If you tell the public 'hey we're going to print money and do whatever it takes to keep deflation from happening' you kind of build up or at least allow inflation expectations not to fall," said Eric Stein, vice president and portfolio manager at Eaton Vance in Boston.

Analysts estimated this week that the yield on the 10-year Treasury note could fall half a percentage point, from around 2.50 percent to 2 percent, if the Fed were to buy another $1 trillion Treasury notes. That heavy spending would have little direct effect on the economy.

Lower Treasury yields could in theory lead more homeowners to refinance their mortgages, thus lowering their monthly payments and freeing up cash to spend on goods and services that would stimulate economic growth.

Lower yields could also force banks to lend more to customers, since they would be less likely to be able to turn a profit by trading on the spread between Treasuries of different maturities.

But the Fed's eye isn't on these effects, which aren't likely to be brought about by more Treasury purchases at this point. Instead, Fed officials will likely try to use easing ammunition to spark inflation fears.

"If you take interest rates down to 2 percent it probably will spark some inflation concerns because that is an extraordinarily low level of rates," said David Ader, head of government bond strategy at CRT Capital Group in Stamford, Connecticut.

"If the fed buys here and now, it's called interest-rate insensitive buying," Ader said. "They're not buying for economic reasons, they're trying to drive rates lower than the market itself might clear."

That would, in turn, make consumers and investors believe that conditions in the marketplace were about to turn. With rates at what Ader called "unnatural levels," market participants might start to believe, for the first time, that prices and rates had gone as low as they could possibly go. Instead of waiting for further price decreases, they might finally start to buy, borrow and hire again ahead of a coming increase in prices and interest rates.

"When the central bank signals its willingness to fight deflation, we think that could have a strong impact on inflation expectations, on risk-taking and business confidence," said Zach Pandl, U.S. economist at Nomura Securities in New York.

"We see the main transmission method as working through confidence and expectations rather than working mechanically through interest rates and borrowing."

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Wall Street is eagerly anticipating another round of easing measures from the Federal Reserve, but the most visible results of new Fed action could materialize in investors' minds; not their pockets. Economists are expecting the Fed to start buying Treasuries again,...
More Fed Easing Boils Down to Mind over Markets
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2010-48-24
Friday, 24 Sep 2010 01:48 PM
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