As of late, the Federal Open Market Committee has put its money where its mouth is and said it will be purchasing up to $300 billion of longer-term Treasury notes over the next six months to help stimulate the economy.
According to Bloomberg.com, the Fed has not purchased Treasury securities since 1961 under the Kennedy Administration. This has left many wondering what the short- and long-term effects will be on the markets and economy.
Short-term results can already be observed as Treasury rates hover near historic lows leading mortgage rates below 5 percent. Most have heard that mortgage rates are dropping but may be curious how this outcome has come to fruition. For starters, interest rates have an inverse relationship with Treasury prices. Our federal government is printing money with one hand and purchasing Treasury debt with the other hand in order to push prices upwards. This act should lower interest rates in hopes of stimulating the real estate markets via new purchases and refinancing. In the short term, this is great news as many will have the opportunity to lower their mortgage interest or afford a home.
However, what happens if the Fed’s printing machines heat up and its balance sheet becomes bloated? For starters, inflation risk and interest rate risk become an inherent threat to investment portfolios and detrimental to anyone living off fixed investments. There are many economists, national and abroad, closely watching our rate of inflation which has been dropping over the last six months. Yet, many analysts believe the question is not whether our economy will need to fight inflation, rather how long until it begins to show its face.
As our government pulls out all the tools necessary to fight the recession, putting their worries of inflation on the back burner may be the better of two evils. It may prove wise, even if early to the game, to begin looking at ways to hedge against potential inflation within your portfolio.
Treasury inflation protection securities are one of the most notable avenues to diversify your portfolio and hedge against inflation risk. There are risks as they are not a safe haven against recession, but they have historically done well once prospects of inflation are on the horizon.
A more intricate trade to watch is our Fed attempting to drive interest rates even lower by pushing up the price of treasuries. Many analysts believe $300 billion will not suffice in effectively driving yields lower. Yet, the successful act of artificially driving rates even lower in the treasury markets may be similar to pushing a beach ball under water. It may be a matter of time before rates pop back to the surface, driving treasury prices down to more modest levels. Similarly, economic indicators showing the stimulus eliciting a recovery or a jump in inflation could flush investors from treasuries causing prices to go south.
Griffin Dalrymple, a financial adviser with Coastal Wealth Investment Group, LLC., can be reached at 847-0035, ext. 222.