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Macro View: Fed To Keep Buying Bonds

Stocks in this article: DOW

The Federal Reserve will maintain its bond buying program for the time being and address changing the policy in the middle of March. Currently, the Fed is buying $40 billion of mortgage debt and $45 billion of treasuries a month in order to boost the economy. Chairman Bernake has stressed that this program will continue until unemployment drops from 7.9% to 6.5% and as long inflation remains under the 2.5% target. [Related:  Consumer Confidence is Up, Here Are 6 Undervalued Consumer Goods Stocks]

The program should continue over this next year, given that economic growth is expected to hover around 1.8%. Hitting this projection will result in unemployment dropping to 7.7%, which is well above the 6.5% target. Growth is still below what is needed to restore the economy to previous conditions, even with the housing market showing strong signs of improvement.

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Fed officials are starting to ask the question of what will happen once the Fed finally curbs its quantitative easing policy and increases the federal funds rate from current near zero levels. The Fed’s asset balance has ballooned from $900 billion in 2007 to $3.08, with an addition of $1.02 trillion expected by the end of 2013. Nobody knows for sure what will happen once the Fed decides to unload these assets and Fed officials are worried about inflation and other disruptive effects on the markets that could follow the sell off.

The reason the Fed has been actively buying securities is an attempt to increase the money supply. By doing so, the hope is that financial institutions will use this increased capital to improve lending and liquidity. We haven’t witnessed a boom in economic activity since increased capital doesn’t mean financial institutions and companies are confident in the market and willing to take more risk and increase investments.

Why is this important? Forgetting to follow the Feds actions could really hamper your portfolios returns going forward. Keep an eye out for economic improvements and remember that this could mean the Fed will start to reverse its current policy and begin unloading assets and raising interest rates. It remains to be seen what this will all do to the markets, but that doesn’t mean you shouldn’t factor in the associated risks and keep tabs on any new developments.

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