Since September of last year, the Federal Reserve has been buying $85 billion in bonds every month, aiming to lower long-term interest rates and boost economic growth. Overall, the U.S. central bank has bought more than $2 trillion of government bonds, private debts, agency housing debts and other bond instruments dating back to the Financial Crisis. It has paid for these purchases by crediting funds to the reserves of private banks, which is commonly referred to as “money printing.”
The Fed began printing money because, in its view, the crisis plunged the country into a “liquidity trap,” a situation in which many people hoard cash due to uncertainty and the lack of good options for a decent return. America spent most of the 1930s in a liquidity trap; Japan has been in one since the mid-1990s; and the Fed is operating as if the U.S. is in one now.
Economists who study liquidity traps, including Fed Chairman Ben Bernanke, argue that some of the usual rules of economics don’t apply as long as the trap lasts. Budget deficits, for example, do not drive up interest rates in a liquidity trap, and printing money does not have the same inflationary effects in the economy. That’s why the Fed has been mostly comfortable with its extraordinary bond purchases.
As inflation remains low, there are signs that Fed measures are propping up the economy and that its policies are having their intended effect. The Dow has posted record highs, and the housing market is showing signs of renewed strength.
So, recent economic news implies that the U.S. economy may have turned a corner and that the long-touted recovery is at last gaining steam. Although good for the long-term, this situation can create some dislocations in the short- to intermediate-term. As markets begin to price in the eventuality of the Fed “tapering” its bond purchases, with an eye toward eventually ending them altogether, indications are that investors could see a sustained rally in Treasury yields. This can put downward pressure on stocks, as institutional investors move money from stocks back into Treasuries.
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With these types of market abnormalities, it is all the more important that investors make sure they are properly allocated and that they stick with their plan. Long term, investors of all stripes would benefit from this return to a more normalized market environment, but there could be bumps along the way. Please give one of our investment advisors a call at 1.888.86.AZZAD to discuss your asset allocation and investment plan to make sure that you’re positioned to ride out this potential volatility.