Since Federal Reserve Chairman Ben S. Bernanke in September began a third round of asset purchases aimed at lowering interest rates and spurring growth, bond yields have climbed. The trend may signal that his program is working.
Yields on the benchmark 10-year Treasury note have risen to 2.02% from 1.72% since the Fed announced new bond buying on Sept. 13, Bloomberg Bond Trader prices show. Those on bonds backed by home loans have increased to 2.01% as of yesterday from 1.26%, according to the Bank of America Merrill Lynch U.S. Mortgage-Backed Securities Index.
Interest rates are climbing as asset purchases help bolster confidence in economic growth, said James Hamilton, an economist whose research on Fed bond buying has been cited by Bernanke. U.S. stocks have advanced 3.3% since Sept. 13 as the outlook has improved, while yields on junk bonds have shrunk to within 4.78 percentage points of Treasuries as of yesterday from 5.5 percentage points.
“As the economy picks up, we’d expect that would be a force putting upward pressure on yields regardless of what the Fed is doing on the bond supply side,” said Hamilton, a professor at the University of California, San Diego, and former visiting scholar at Fed district banks including Atlanta and New York. “That’s what’s happening, and the Fed should be happy to see it.”
The Federal Open Market Committee today concludes a two-day meeting in Washington and will probably decide that the benefits of continuing to buy $85 billion in securities each month outweigh the risks from a ballooning balance sheet, according to 44 economists in a Bloomberg survey conducted Jan. 24-25. The Fed hasn’t set a limit on the size or duration of its purchases while pushing its total assets beyond a record $3 trillion.
Economic Strength
The third round of so-called quantitative easing, or QE, has probably held mortgage rates 20 basis points to 40 basis points lower than they otherwise would be, said Jonathan Wright, former assistant director of the Fed’s Division of Monetary Affairs. A basis point is 0.01 percentage point. Signs of economic strength have obscured those benefits by nudging interest rates higher, said Wright, an economics professor at Johns Hopkins University in Baltimore.
“QE marginally improves the economy, which drives rates back up,” he said, adding that the current round of asset purchases lacks the clout of the prior two programs.
Smaller ‘Pop’
“The reactions to recent QE announcements suggest that it does still have effects, though not anything as big as the pop you got” from the first large-scale asset program, he said.
The Standard & Poor’s 500 Index, the benchmark for U.S. equities, was little changed at 1,507.91 at 10:00 a.m. in New York, swinging between gains and losses as contraction in the American economy prompted bets the Fed will be in no rush to end stimulus.
U.S. gross domestic product during the fourth quarter shrank at a 0.1% annual rate, the worst performance since the second quarter of 2009, when the world’s largest economy was still in the recession, Commerce Department data showed. The median forecast of 83 economists surveyed by Bloomberg called for a 1.1% gain in GDP.
Bernanke estimated that the Fed’s first round of securities purchases, announced in November 2008, reduced the yield on 10- year Treasuries by between 40 basis points and 110 basis points. The Fed bought a total of $1.7 trillion in mortgage bonds and Treasury securities. The second round, totaling $600 billion and announced in November 2010, cut yields an additional 15 basis points to 45 basis points, Bernanke said in a speech in August at a Fed conference in Jackson Hole, Wyoming.
Impact Varies
“So far, we think we are getting some effect, it is kind of early,” Bernanke said Jan. 14 at the University of Michigan’s Gerald R. Ford School of Public Policy in Ann Arbor, referring to the current round of bond buying. “We are going to continue to assess how effective” the program is “because it is possible that as you move through time and the situation changes that the impact of these tools could vary.”
Rising stock prices and inflation expectations suggest the Fed’s asset purchases are fueling the expansion, said Mark Gertler, a New York University economist and research collaborator with Bernanke. The Fed chairman said last month bond buying will continue until the job market shows “substantial” gains. Unemployment in December was 7.8%.
More Jobs
“Given the uncertainty about the economy when the Fed launched QE3, my guess is the Fed is pleased with the outcome thus far,” Gertler said. “A stronger economy does point to more jobs.”
Expectations of inflation as measured by the Fed’s five- year five-year forward breakeven rate, which gauges the predicted pace of consumer price increases from 2018 to 2023, rose to 2.88% on Jan. 25 from 2.63% after the FOMC meeting in September. The Fed targets inflation of 2%.
Rising stock prices may boost consumption through a so-called wealth effect, said Paul Dales, a senior U.S. economist at Capital Economics Ltd. in London. Meanwhile, increasing inflation expectations will probably stoke borrowing by reducing the “implied real interest rates,” or expected interest rates after accounting for inflation, he said.
The effectiveness of asset purchases is at the core of an FOMC debate over how long to continue the program. The minutes from the FOMC’s Dec. 11-12 meeting show participants who provided forecasts were “approximately evenly divided” between those who said it would be appropriate to end the purchases around mid-2013 and those who said they should continue beyond that date.
Tighten Policy
A number of policy makers are concerned the magnitude of the Fed’s balance sheet could impair its efforts to tighten policy when necessary, according to the minutes.
“We have a cost-benefit type of approach” in weighing whether to push on with asset purchases, Bernanke said in Ann Arbor.
Not all of Bernanke’s colleagues believe quantitative easing is worth the risks. Kansas City Fed President Esther George has signaled she may dissent today from any pledge to continue bond buying, said Diane Swonk, chief economist for Mesirow Financial Holdings Inc. in Chicago.
George and St. Louis Fed President James Bullard, who’s also voiced concern about the risks from quantitative easing, gained policy votes this year as part of an annual rotation among Fed regional bank presidents on the FOMC.
Record Stimulus
George said in a Jan. 10 speech she is concerned record stimulus may cause imbalances in financial markets, citing how prices of bonds, agricultural land and high-yield and leveraged loans are near historic highs.
“It’s a very aggressive policy, and it is making me a little bit nervous that we’re over-committing to easy policy,” Bullard said the same day in Madison, Wisconsin.
Their concerns probably won’t derail a pledge today by the FOMC to maintain the pace of securities purchases, Swonk said. “The Fed will pursue steady policy with a continued expansion of the balance sheet.”
The housing market is recovering as the Fed presses on with record easing. Combined sales of new and previously owned properties last year rose 9.9%, according to data compiled by Bloomberg, for the biggest annual gain since 1998 and an indication residential real estate is helping drive growth.
Home prices in 20 U.S. cities rose in the 12 months to November by the most in more than six years. The S&P/Case- Shiller index of property values increased 5.5% from November 2011, the biggest year-over-year gain since August 2006, according to data released yesterday.
“The housing market began a steady rebound” last year, Chief Executive Officer John G. Stumpf of Wells Fargo & Co., the largest U.S. home lender, said in a conference call with analysts and investors on Jan. 11. “There is no doubt that a corner was turned, which is a real positive for our economy.”
