Why Quantitative Easing Is Clearly Working

by: HiddenValueInvestor

The Federal Reserve decided to launch another round of quantitative easing today in a move commonly referred to as QE3. The Federal Reserve announced an open ended commitment to purchase $40 billion in Agency Mortgage Bonds each month. The economy is still weak and needs additional accommodation from the Federal Reserve.

The Federal Reserve has achieved significant success with its first and second quantitative easing programs. The objective of quantitative easing is to lower interest rates and increase asset prices to spark economic growth. It is designed to crowd investors out of the safest investments, such as U.S. Treasuries, and force them out on the risk curve to earn a higher return. The Federal Reserve started quantitative easing with an announcement in November of 2008 that it intended to purchase $500 billion in Agency Mortgage Bonds. At that time the 30 year fixed Treasury rate was 6.1%. Today, that rate is down to 2.9%. The interest rate on a 30 year mortgage in November of 2008 also averaged 6.1%. Today the rate on a 30 year mortgage is down to 3.5%.

The S&P 500 was trading below 900 in November of 2008. Today it has recovered most of its losses and is trading at over 1,400 points. The price of oil on the NYMEX dropped below $50 per barrel just prior to the Federal Reserve launching the original quantitative easing. Today, oil is trading for over $90 on the NYMEX. It is clear the Federal Reserve achieved its primary objectives with quantitative easing of lowering interest rates and raising risk asset prices such as stocks and commodities. The Federal Reserve also wanted to restore confidence in the economy and reduce unemployment with quantitative easing. Here, they have also been successful, but the overall measurables are not as favorable as they are with reduced interest rates and increased asset prices.

Many argue that with the Unemployment Rate still over 8% and weak GDP growth still averaging 2%, that quantitative easing has been a failure and its inflationary costs clearly outweigh its benefits. They do not accept the counter factual argument that the economy would be in much worse shape without quantitative easing. It is true the economy remains severely depressed. But the fact is whether people accept it or not the economy would be in much worse shape without quantitative easing.

For example, the bursting of the housing bubble collapsed housing starts to fall to a low of 478,000 in April of 2009. In July of 2012 housing starts have risen to 746,000. New home construction was rapidly declining in November of 2008 and now new home construction is on a rising trajectory. The reason housing starts are up is because 30 year fixed mortgage rates have declined from 6.1% to 3.5% making new homes more affordable. This has benefited large home builders like Toll Brothers (NYSE:TOL) and Lennar (NYSE:LEN). The increase in housing starts also benefits large mortgage lenders like Bank of America (NYSE:BAC) and Wells Fargo (NYSE:WFC). The objective of QE3 is to make further gains in improving the housing market and the Federal Reserve has left its commitment open ended. This creates a buying opportunity in home builders and banks with large mortgage operations.

The U.S. has experienced a boom in shale oil. But most of those oil wells are not profitable with oil prices under $50 and would not have been drilled. Because oil prices have risen the rig count has risen from a low of 876 rigs operating in the U.S. in June of 2009 to 1,864 rigs in September of 2012 benefiting rig companies like Halliburton (NYSE:HAL), Noble Energy (NYSE:NBL), Schlumberger (NYSE:SLB), and shale oil exploration and production companies like Whiting Petroleum (NYSE:WLL), Continental Resources (NYSE:CLR), EOG Resources (NYSE:EOG), and Kodiak Oil and Gas (NYSE:KOG). QE3 is causing a devaluation of the dollar thereby raising the value of commodities that trade on world markets like oil and the companies that search for oil. Gold is another beneficiary of a falling dollar and gold mining stocks like Newmont Mining (NYSE:NEM) and Barrick Gold (NYSE:ABX) are well off of their highs even though gold is approaching its high.

Finally, the last benefit of quantitative easing has been a devaluation in the dollar against a basket of world currencies. A lower dollar makes American exports more competitive on a price basis. It also raises the price of imports, making American made products more competitive with the price of imported products, especially those from Canada, Europe, and Japan.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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