(December 13, 2012) — The Federal Reserve is doing all it can to keep long-term interest rates low, so how will investors respond?
The Fed will spend $45 billion a month to sustain this aggressive drive, with plans to keep a key short-term rate near zero until unemployment drops below 6.5%, it has revealed. With the economy’s relatively slow growth, and 7.7% unemployment in November, the Fed says its policies are meant to jumpstart the economy. It said it will direct the money into long-term Treasurys, replacing an expiring bond-purchase program. The new purchases will expand its investment portfolio, which has reportedly reached nearly $3 trillion.
“This is the challenge institutional investors face. With interest rates at such lows, investors are facing negative real yields,” Erik Knutzen of Boston-based consulting firm NEPC told aiCIO. “To meet their return objectives, many are forced to move to riskier areas, and for those not ready to do so…well, they just need to support the reality of lower returns.”
Knutzen added: “The Fed announcement has been well-forecasted, and their actions are justified. What they’ve been doing has been working to a certain extent: they’ve been able to spur a moderate level of growth in the US that has been higher than the inflation rate. We’re gradually digging our way out, but that’s not without risk of future inflation along with financial repression in the near-term.”
Pacific Investment Management Co.’s Bill Gross, manager of the world’s biggest bond fund, said the Fed’s latest round of monetary stimulus will help the Treasury department to issue debt for no cost. “What really happens, and this is critically important, is that the Treasury issues bonds and the Fed buys them and then it remits interest to the Treasury,” Gross told Bloomberg. “It means the Treasury is issuing debt for free. There are complications. Inflation is one of the complications.”
Analysts have said that the Fed’s plans will make it easier for companies, investors, and consumers to make financial decisions, due to the fact that they will have a fuller picture of when borrowing costs will begin to increase. “This approach is superior” to setting a timetable for a possible rate increase, Chairman Ben Bernanke said at a news conference. “It is more transparent and will allow the markets to respond quickly and promptly to changes” in the Fed’s economic outlook.
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