A Gold Star For Fed Chairman Bernanke And The FOMC

Remember in grade school when you did something so special the teacher rewarded you with a gold star? Well, the Surf Report would like to award a gold star to Chairman Bernanke and his clever bunch of governors.

Why? You may ask; since the chairman simply did his job and the FOMC statement was relatively benign. However, the brilliance and pure genius comes in the subtle structure of his essay.

As expected the Fed announced quantitative easing (QE) will come to an end. In order to transition the market from QE to no QE the Fed extended end date of Treasury purchases until October. Brilliantly, purchases of mortgage securities are continued to year end. In an inspired fashion the Fed has set up an environment where US Treasury rates can rise, while mortgage rates remain low.

The Fed’s conundrum is it serves two masters. The economic recovery requires low mortgage rates to stimulate the housing market, while foreign investors require higher rates to finance the US debt. Chairman Bernanke has figured out a way to accomplish both.

By slowly weaning the Treasury market from Federal Reserve buying, the Chairman can allow
Treasury rates to rise and satisfy US creditors. At the same time, the Fed will use its substantial balance sheet to buy mortgages, having the effect of keeping mortgage rates low.

The predecessor of this strategy has been in place since the beginning of quantitative easing. The mismatch between the amounts devoted to buying mortgages and Treasuries caused the spread to narrow.

With this new/continued policy the spread should narrow over the next 4 months. After October, the Federal Reserve will only buy mortgages, leaving Treasury rates to float wherever the current takes them.

In short, the wise Chairman has given the Treasury overdraft protection by offering our creditors a higher rate while also stimulating the housing market. It is an elegant plan and we applaud its architect…and hope it works.

Disclosures: None

Subscribe by RSS Subscribe by Email