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This week sees a heavy flow of data releases from the U.S., the results of which are likely to influence the Fed’s decision to “taper” the amount of bond purchases it makes as part of its Quantitative Easing program.
This seems like a good time to cover just what Quantitative Easing actually is and why it was implemented in the first place. Because it appears many investors have a few misconceptions about the Fed’s bond buying policy and its effectiveness.
In a normal world the Fed would try to stimulate the economy by lowering interest rates. Lower interest rates encourage people to spend, therefore pumping more money into the economy.
But with interest rates at near zero, they effectively can’t go any lower. So the Fed has to use a different tactic. What the Fed decided to do was pump money into the economy directly, this is the process called Quantitative Easing.
To do this the Fed buys assets – in this case mortgage backed securities and U.S. Treasury bonds – using money it has created out of thin air. This is why some commentators refer to QE as money printing.
The institutions selling those bonds (either commercial banks or other financial businesses such as insurance companies) will then have “new” money in their accounts, which (in theory) boosts the amount of money they can invest back into the economy.
Quantitative Easing is not a new tactic and it wasn’t invented by the Fed. It was first used by the Central Bank of Japan to get out of a period of deflation following the asset bubble collapse in the early 1990s. Did it work? Well, not exactly. But that’s a whole different story.
Todays Other Top Stories
FT: – What the Fed will do with its taper and why. – This week’s heavy schedule of data releases will likely have a big, if not determining, say in “when” and “how” the US Federal Reserve tapers its quantitative easing programme – that is, start moderating its exceptional support for markets and the economy. And while most assessments will focus on the timing, scale and scope of the policy adjustments, the “why” will be as important, if not more so in shedding light on what may lie ahead.
ETF Trends: – Bond ETFs vs. Equity ETFs. – Welcome to the second instalment of our Master Class on bond ETFs, where we go beyond the basics to learn how these funds work and gain an understanding of their features and benefits. Last time, we talked about the three key elements of a bond ETF. Now that we’ve laid the foundation, the next concept to tackle is how they compare to stock ETFs.
Learn Bonds: – The risk of rising rates. – Most of the investing public, both individual investors and professionals, have had the majority of their experience in the markets in a bullish bond market. Rates hit a peak of 15.3% in 1981 and from there, trended down to a low of 1.4% in July 2012. While there were periods of time where rates rose for a bit, the overall trend has been down. As rates fall, prices of bonds rise.
MoneyBeat: – Verizon’s jumbo bond could even top Apple’s. – Investors in Europe, as well as in the U.S., are licking their lips in anticipation of Verizon’s jumbo debt sale that will partly finance its acquisition of Verizon Wireless.
Forbes: – Muni bond manager’s journal: Make sure your ratios are rational. – When is a buying opportunity truly a buying opportunity? That’s the question municipal bond investors need to ask themselves today when considering one of the most frequently used barometers of relative value: the Municipal/Treasury ratio.
FT Adviser: – If you have to buy bonds, buy me. – Philip Scott talks to the head of credit at Ignis about why bonds represent a risky investment for the inexperienced investor.
Focus on Funds: – Fed dread August’s ETF outflows a record-breaking $15B. – Where’s the ETF money heading lately? Away from bonds amid worry of the Federal Reserve’s “taper,” and into Old World stock markets.
Zolmax News: – PIMCO predicts mortgage bonds to get worst slump since 1999. – U.S. government-backed mortgage bonds are seen to head towards their longest monthly slump since 1999. Analysts attribute the drop to the pulling back of the Federal Reserve’s stimulus program in time when the rising home loan rates has slowed down the housing rally.
Money Morning: – Muni Bonds: Beware this major flaw in Moody’s rating system. – The fallout from Detroit’s bankruptcy filing has investors – and even ratings agencies – questioning the validity of the bond rating system. Now investors need to know if it can be fixed in a way that actually helps those investing in general obligation (GO) bonds.
FT Adviser: – Schroders manager tips high yield to lead bond returns. – Bond manager says high yield will prove most resilient as volatile markets return in coming months.
New York Times: – The jury is still out on the wisdom of buying bonds. – Global financial markets have spent more than four years gorging at an all-you-can-eat buffet laid out by the U.S. Federal Reserve and other central banks. The Fed has signaled that the feast is about to end, and bond investors are discovering that they have been presented with the bill.
USA Today: – Investors start to flee bond ETFs as rates rise. – Bond ETFs have seen steady inflows through much of 2013 but the trend has reversed the last month as the rise in interest rates kicks into high gear on speculation the Federal Reserve will begin pulling back from economic stimulus sometime before the end of the year.
Bloomberg: – Florida dodging storms yields cash as bonds suffer. – Florida’s government-run insurance system has amassed record cash reserves as hurricanes bypassed the state since 2005. That hasn’t helped investors in its bonds, with some trailing benchmarks by the most since February.
Dallas News: – The long-running bull market in bonds appears to be over. – Night has descended on the bond market. It has taken more than three decades, but the bull market in fixed-income investments, which began in 1982, has finally stalled. Investors are withdrawing money from their bond mutual funds and exchange traded funds at a pace never seen before.
Macro Micro Analytics: – Implication for key bond ETFs in a changing rate environment. – This analysis assesses the impact of changing interest rates on a number of ETFs, which collectively hold $63.2 billion in investor assets, and could experience material price changes in a shifting interest rate environment.
Bloomberg: – Florida dodging storms yields cash as bonds suffer: Muni credit. – Florida’s government-run insurance system has amassed record cash reserves as hurricanes bypassed the state since 2005. That hasn’t helped investors in its bonds, with some trailing benchmarks by the most since February.
Bloomberg: – Michigan’s Oakland County poised to delay $350 million bond sale. – Michigan’s Oakland County, which borders Detroit to the north along 8 Mile Road, may delay a $350 million debt sale that was set for next week because officials are behind schedule in assembling bond documents, Deputy Executive Robert Daddow said.
Gross: Just to let you know: market pricing in 4% Fed Funds by late 2018. ??
— PIMCO (@PIMCO) September 3, 2013
— PIMCO (@PIMCO) September 3, 2013
PIMCO Total Return fund is down $41bil since 4/30. $PTTRX
— David Schawel (@DavidSchawel) September 3, 2013