ARGUS-COURIER REAL ESTATE COLUMNIST
Published: Thursday, December 9, 2010 at 3:00 a.m.
In the statement released after its November meeting, the Federal Reserve announced that it will purchase an additional $600 billion of longer-term treasury securities by the end of the second quarter of 2011 in what is known as another round of quantitative easing.
That means, including treasury purchases from reinvesting proceeds of mortgage payments, the Fed will purchase $850 to $900 billion in securities through June 2011, which equals about $110 billion per month.
Quantitative easing is the concept of the Fed becoming a heavy buyer of treasuries and bonds. This is done to artificially cause those security prices to move higher under the increased demand. That demand should, in turn, cause interest rates to move lower in the hopes of stimulating the economy.
While that sounds easy enough, it’s not an exact science. In fact, not too long ago, Fed chairman Ben Bernanke noted that the Fed has much less experience in judging the economic effects of more QE versus their more traditional monetary policy actions. He went on to say that this “makes it challenging to determine the appropriate quantity and pace of purchases and to communicate this policy response to the public.” More recently, Bernanke compared the Fed’s handling of the next round of QE2 to a golfer with a new putter, stating that the golfer has to tap lightly at first and try to figure out how to use it properly. Those words don’t exactly inspire confidence in the Fed’s ability to get QE2 right.
Even if the Fed does get it right, we have to keep in mind that QE has drawbacks and unintended consequences. For example, another round of it will continue to load the U.S. with debt. Additionally, QE2 would likely lead to a weaker U.S. dollar. While a weaker dollar may make our exports more attractive to foreign buyers, it could ultimately drive rates higher.
That brings us to another potential result of the Fed’s purchases: inflation. Recently, a news story explained how another round of QE brings the risk of “unleashing the 1970s inflation genie.” Consumers who are looking to purchase or refinance a house should take note of that possibility — even talk of inflation can impact home loan rates negatively. After all, a rise in inflation would be bad for mortgage bonds and, as a result, for home loan rates.
For months there has been an ever-growing fear that our economy is headed towards deflation. After all, the talk of QE, however, those fears have receded and even turned into talk of inflation. But how do concerns over inflation and deflation really impact home loan rates?
Let’s start by clarifying the terms. Deflation is when prices on goods and services fall lower. Inflation, on the other hand, occurs when prices climb higher.
Now, when we consider those ideas in terms of home loan rates, we see that fears of deflation are good for Bonds and home loan rates. That’s because the fixed payment that a bond provides to an investor goes further in a deflationary environment. So, the recent fears of deflation have helped Bond prices move higher and home loan rates move lower.
But the exact opposite is also true — meaning that fears of inflation negatively impact bond prices and home loan rates.
So, all the talk about QE and potential inflation (as discussed above) is ultimately bad for bonds and home loan rates.
The point is — this story is far from over. The Fed may have announced its plan for QE2, but now we have to wait and see how it may benefit the economy as a whole, or negatively impact home loan rates.
(Brent Blaustein is a loan agent with Princeton Capital. He can be reached at 769-4327.)
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