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  • Soaring Bond Yields and the FED’s Sea of Red Ink 0 comments
    Dec 19, 2010 4:59 AM

      By, David Frank

    If Ben Bernanke, the chair of the FED, was an investor he would be disappointed and in some trouble.  The first round of the Federal Reserve’s $600 billion Treasury bond purchase program is in the red, thanks to soaring yields. The Central Bank’s inexpensive financing makes outright losses unlikely, but Bernanke can still face an image problem.
    To the extent the FED’s second round of so-called quantitative easing (QE2), was designed to keep a lid on interest rates, it has not worked, bluntly it has backfired. Since the program was introduced in early November, 5-year yields have soared more than 0.9 percentage points higher, eradicating the initial yield slump seen after the FED first hinted a few months earlier that another round of easing was being planned.
    Primarily and after President Obama announced he would extend Bush era tax cuts another two years including tax breaks for millionaires, rogue bond investors reacted extremely negatively and sold US Treasures in the market forcing interest rates to soar.
    A little micro economics here… when bond yields rise, prices fall. As a result, the FED’s first $116 billion of QE2 purchases were worth approximately $113 billion at the end of active trading on Tuesday, a loss on paper of nearly 3 percent.
    Of course, the Fed won’t be selling those securities anytime soon. The economy and employment situation will have to improve considerably before that happens. But a continuation of the recent rise in yields would bring much lower valuations by then. Thus, causing the FED even more future difficulties.
    Even so, the FED may not actually lose any money over all, thanks to its low cost of funds and the interest payments rolling in on its holdings. In fact, the FED’s supersize balance sheet , now at $2.4 trillion, is a cash cow for the Treasury. In 2009, when it was smaller, the FED plumped the government’s coffers by $47.4 billion.
    Yet the slide in government bond values gives those against this stimulus package a great deal of ammunition for questioning the FED’s judgment. The innovative QE2 policy was supposed to stimulate the economy by keeping interest rates low. So far, the opposite has happened. Mainly because the White House is not on the same page as the FED and by passing the tax-related deal in Congress has arguably reduces the need for it. When Mr. Bernanke next has to convince lawmakers that quantitative easing was a good idea, the red ink covering his balance sheets could, and probably will, work against him.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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