The financial headlines tell us that the nation’s central bank, the Federal Reserve (the Fed), is winding down its “quantitative easing” program. This was an unconventional strategy designed to help boost the nation’s economic recovery following the deep recession that occurred between 2007 and 2009. Quantitative easing involved monthly purchases by the Fed of billions of dollars in government bonds. The goal was to provide liquidity to the economy and contribute to a low interest rate environment. That, in turn, was designed to spur more investment by businesses and consumers. The decision by the Fed to end its bond purchasing strategy means it is stepping back from one of its primary strategies to boost the economy.
A strategy in place since 2009
The U.S. economy has experienced a fairly slow recovery since the recession ended. It is one reason the Fed pursued extraordinary stimulus measures to try to keep the recovery on track. The Fed’s bond purchasing program was considered risky by some observers, who feared that it might trigger a return to high inflation. That has not yet materialized, nor has the economy roared ahead, but it has continued to grow.
The Fed has been tapering its easing strategy in recent months and plans to end the bond-purchasing program by October. The Fed’s change of strategy may be a sign of its increased confidence in the economy. At the same time, it raises some concerns that without the Fed’s active program to purchase U.S Treasury securities, interest rates might begin to drift higher.
The Fed remains active
While the quantitative easing strategy may be approaching its end, the Fed continues to maintain low interest rates. The rates it sets on short-term securities are still near 0%, as they have been for several years (as of Sept. 3, 2014). There are some indications that the Fed may keep interest rates near that level at least into 2015. For now, the Fed continues to own the trillions of dollars in bonds it has already purchased in recent years as part of quantitative easing. At some point though, the Fed may scale back its holdings and sell those bonds on the open market. This boost in the supply of bonds could result in higher interest rates.
In recent years, yields on government bonds have lingered near historic lows but started moving higher in 2013. One benchmark measure of interest rates is the yield on 10-year U.S. Treasury notes. At the start of 2013, the yield was up to 3%, but it has dropped to as low as 2.34% this year.* When bond yields decline the value of bonds in the market rises. As a result, bonds have enjoyed a solid year of performance to date. The question now – where will interest rates go from here? Yields on U.S. Treasury securities are hovering near historic lows. There is a chance they could begin to jump higher again, which might result in higher mortgage rates, but may also provide a way for fixed income investors to boost the cash flow they generate from bonds. The results and timing of any change in the direction of interest rates is unpredictable. Be sure to talk with a financial professional to design a portfolio that is in line with your objectives, long-term financial goals and time horizon.