On 13 September 2012, Ben Bernanke announced a third round of quantitative easing also known as QE3. What the federal reserve will do is buy $40 billion in MBS and $45 billion in 10-30 year bonds per month. So a year from now, the federal reserve will have bought $480 billion in MBS and $540 billion in 10-30 year bonds.
Zerohedge has projected the federal reserve's balance sheet as given on chart 1.
So basically, the federal reserve will try to spur growth by helping the mortgage market and the bond market. But there is a catch in the deal. What investors need to pay attention to is the yearly interest payment on the U.S. government debt (Chart 2: blue dots). The interest payments include the following items:
- U.S. Treasury notes and bonds
- Foreign and domestic series certificates of indebtedness, notes and bonds
- Savings bonds
- Government Account Series
- State and Local Government series (SLGs) and other special purpose securities.
As you can see, the interest payments on total U.S. debt (blue dots) follow the total U.S. public debt outstanding (red dots). The higher the U.S. debt, the higher the interest payments on this debt.
There are a few periods where the correlation didn't occur (2001-2004 and 2008). This is explained by the bond yields on government debt (Chart 3) and the interest rates (Chart 4).
Chart 3: 10 Year U.S. Bond Yields Vs. Interest Payments
On Chart 3 you can see that when bond yields go down, the interest payments tend to go down with it. This explains why the interest payments during the period 2000-2004 went down, while the total public debt went up. On Chart 4 you can see that the federal reserve slashed interest rates to 0%. This explains why the interest payments in 2009 dropped from $450 billion in 2008 to $383 billion in 2009.
Another point the federal reserve announced was that it will keep interest rates at 0% till mid-2015. The problem is that interest rates are already at 0% right now, so the federal reserve doesn't have any firing power left as it can't set interest rates below 0%. This means that the interest payments will now keep going up absent of interest rate manipulation.
Now, let's quickly run through the numbers. Interest payments on government debt will likely go above $500 billion in the coming year as projected on Chart 2. Especially when U.S. bond yields go up, like it has been doing just recently. The quantitative easing program Ben Bernanke just announced will buy $540 billion of 10-30 year bonds per annum. That leaves only about $40 billion to spur economic growth as the other $500 billion will go to interest payments on U.S. debt. Some analysts say QE3 is less than expected and I agree with that considering the analysis I just did. As a result, bond yields have been rising sharply after the QE3 announcement. 10 year U.S. bond yields went from 1.75% to 1.83% a day after the announcement.
Considering the expanded time frame of zero interest rates till 2015, precious metals posted a big gain due to this announcement of QE3. The U.S. dollar continued to decline against other currencies. Spot gold and silver rose 4.5% (Chart 5). The EUR/USD exchange rate went up from 1.28 to 1.31.
The latest QE3 announcement from the federal reserve is mainly used to pay interest on debt and has low effects on growth. This QE3 is more of a status quo program than a growth program and is unlikely to help the job market in a substantial way. The market has evaluated this QE3 program and realizes that it's too small to put a lid on U.S. treasury yields. As a result, U.S. bond yields quickly rose after the QE3 announcement, while gold and silver prices skyrocketed upwards. I advise investors to get out of U.S. bonds.
Disclosure: I am long PHYS, PSLV, AGQ. 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.