Thursday, September 13, 2012

Fed Lunacy - Larger Training Wheels

We all had to learn how to ride the bicycle with training wheels at first. It was a great practice and a confidence booster. After we grew into the age, when we no longer needed the training wheels, our parents took them off. While it was a little wobbly in the very beginning, we regained the balance shortly and rode the two-wheeler without a problem ever since.

Today, Federal Reserve decided to increase the size of the training wheels, and essentially made them the main wheels for as long as U.S. economy cannot ride without them. When and how exactly the training wheels will come off is anyone's guess. With very little credible evidence of benefit to the economy from previous QE, one has to wonder how long it will take the market to figure out that we are on a clear path towards a wreck. The wheels, which where put on today, are so oversized that the bicycle itself will tip over, thus defeating their purpose of help and serving as a source of an accident for the rider - the economy.
Let's get off the bike and walk through what exactly happened today.

Fed announced that it will purchase MBS in the open market, $40B of them a month, open-ended.  Supposedly this will keep the mortgage rates very low and let the housing market stay energized, while creating new jobs and wealth for American consumers, who will in turn spend more and keep the economy growing, or even make it grow faster. What a brilliant plan!!
So what exactly will consumers get out of the QEInfinity? Because MBS market is not as liquid as treasuries, let's assume that Fed gets a bigger bang for its (or more correctly, OUR) buck and rates on 30-yr. mortgage will instantly drop by 50 bps from the current level. This will result in savings of roughly $66 a mo. for qualified home purchasers and refinancers, based on the median 2012 U.S home mortgage application size of $235K. Hurray!
But what Federal Reserve will not tell you is that today, since the FOMC announcement, gold futures went up $40 per oz., and oil futures touched the highest level since April and are now just a dollar away from the century mark per barrel. Are you getting the picture yet? $40B of newly printed money every month will have to find its home in commodities and other hard assets - due to risk of inflation. So those monthly mortgage savings will be more than eaten up by higher prices at the gas pump and the grocery store, and by higher home utilities costs!

So much for extra disposable income to grow the economy. Or perhaps Fed assumes that we will ride our bicycles with training wheels to work?

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