Quantitative Easing – Ciccarelli 3rd Quarter Update

Federal chairman Ben Bernanke announced in September that the Central Bank will begin buying $40 billion of mortgage-backed securities per month starting in October and will continue to do so until the unemployment picture starts to show improvement. This is the Fed’s third round of quantitative easing (QE3) since the 2008 panic with a goal of further reducing long-term interest rates. (Source: WSJ, September 14, 2012, A12 Bernanke Unbounded) Recently, Mr. Bernanke extended the Fed’s forecast for near-zero interest rates until the middle of 2015. His plan also includes continuing “Operation Twist,” which exchanges short-term securities for those with longer maturities.

The Fed wants to continue pursuing its “dual mandate” of controlling inflation and reducing unemployment. “We have to do more, and we’ll do enough to make sure the economy gets on the right track,” Mr. Bernanke declared.

We still have not yet felt all of the ripple effects of these new policies, but one of them is the risk of future inflation, which Mr. Bernanke stated hasn’t strayed too far above the Fed’s 2% “core inflation” target. Unfortunately, this ignores the increase in food and energy prices, which consumers pay even if the Fed discounts them in its “core” calculations.

After three decades of decline, many investment advisors believe rates could be on their way back up soon. Pinpointing the timing of an interest rate rise is difficult, if not impossible. After the global economic crisis in 2008, many investors flooded into U.S. Treasury bonds, which consequently pushed their yields down. Unfortunately, if interest rates start increasing, the value of many bonds will decrease.

There are several potential drivers of higher interest rates. One might be inflation. While it has been fairly tame for years, if commodity prices and other costs start to climb, inflation could begin to creep higher. A consequence of higher inflation is typically higher interest rates