from
(snip)"The most notable thing about the week just gone by was that the Fed quietly bought a slug of TIPS from the Treasury at Wednesday’s auction, and it did not involve a rollover. I could find nary a word about it on the Fed’s various websites and it didn’t settle until Thursday, so I will have to wait for next week’s H41 in order to say, with apologies to the late great Jack Buck, “I can believe what I just saw.”(snip)
In basic terms, this means that the FED is now deploying 'newly printed' dollars to take variable interest rate paying US TIPS bonds 'off the market'. This of course is the very same FED that decides how much 'new money' is to be printed as well as how high (short term) interest rates will be on fixed interest rate US bills and bonds. TIPS bonds are of course one of the favorite refuges for conservative investors wishing to hedge risk of US dollar inflation / exchange rate loss / purchasing power loss. On the flip side TIPS bonds automatically cost the US gov't ( taxpayer ) MORE money to service if and when US interest rates rise.
The potential take-away from the FED's 'quiet' purchases of TIPS bonds is that increasing US interest rates, increasing US Dollar money supply, US dollar based price inflation etc. ... with an associated loss of US dollar purchasing power / exchange rate ... are now being actively considered for implementation.
The speculative question is why, after a couple of years of FED policy to maintain interest rates at record low ( and supposedly stimulative ) levels, would the FED now be actively considering a change in that policy ? Well, as with all such questions, the answer can usually be found by 'following the money'.
- With the end of US gov't subsidy programs for autos, first time housing etc. it is now clear that American consumers are not taking on new long term fixed interest rate debt. Thus raising interest rates will not do further harm to these markets.
- with financial uncertainty about 2011 - 2012 'costs of doing business' weighing heavily, US industries are choosing not to take on additional debt to expand their business ( in fact they are sitting on unprecedented amounts of cash ). Thus raising interest rates would not do further harm in the area of business expansion / job growth that aren't happening under low interest rates !
- Banks who are not able to make any money writing new fixed interest rate loans for autos and housing ARE able to make money on variable interest rate debt i.e. credit card debt, ARM mortgage debt etc. If interest rates were to increase, banks holding variable interest rate debt earn more money from the existing debts they already hold - which lessens the future potential for yet another gov't bank bailout becoming necessary.
- Federal, state and local gov't debt ( with the exception of TIPS and a few other types) is all fixed interest rate. Thus US dollar inflation makes this debt easier to service. This is doubly true if the same US dollar inflation causes rising prices ... which automatically translates into rising sales tax revenues, rising property tax revenues etc.
- While rising interest rates are likely to 'crush' marginally bankrupt ARM homeowners and those knee deep in credit card debt via increasing monthly payments, in all probability rising interest rates would only accelerate the bankruptcies that were going to happen in any case. But on the flip side, rising interest rates won't materially affect fixed interest rate mortgage homeowners, fixed interest rate auto loan borrowers etc.
- rising interest rates / inflation rates would not materially affect union / gov't employees whose contracts include COLA's. They would also not materially affect social welfare recipients whose benefits are COLA adjusted.
- perhaps more importantly, rising US dollar interest rates will serve as an enticement for foreign lenders ( i.e. China, Middle East, Japan etc. ) to continue buying newly issued US treasury bonds that are absolutely essential to allow the US gov't to continue spending more money than it is able to take in via tax revenues.
- lastly, valuation levels of most US stock market equities always rise 'on paper' when interest rates rise. Given that distressed retirement plans across the country ( gov't based, union based, and private ) are dependent on the valuation levels of US stock market equities they own in order to meet pension obligations, these retirement plans all need a higher 'on paper' rate of return to avoid facing major solvency problems.
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