Some things are worth repeating so that their potential effects may be fully appreciated. San Francisco Fed President Mary Daly recently said that the U.S. central bankers are currently debating whether it should confine its controversial tool of bond buying to purely emergency situations or if it should turn to that tool more regularly.
In the financial crisis, in the aftermath of that when we were trying to help the economy, we engaged in these quantitative easing policies, and an important question is, should those always be in the tool kit, should you always have those at your ready, or should you think about those are only tools you use when you really hit the zero lower bound and you have no other things you can do.
Then she stated the almost unthinkable, from a few months ago,
You could imagine executing policy with your interest rate as your primary tool and the balance sheet as a secondary tool, but one that you would use more readily. That's not decided yet, but it's part of what we are discussing now.
This idea will have a profound influence on both the bond and equity markets, if instituted. It first means that the Fed will always be "IN!" Meaning that the Fed is going to determine, on a constant and ongoing basis, whether Quantitative Easing should be used, for any of a number of reasons. It also means that they Fed will always be in control, because you can't fight the people that make the currency. You have no chance, zero, of going against them because you do not have the same power that they do, which is to print money.
If the Fed does decide to pursue this strategy it will be a wholesale change in the way the financial system in the United States operates and I think that very few institutions or people appreciates what is taking place or what it will means to the markets, all of the markets. This new concept dramatically enforces my opinion that interest rates will be "lower for longer and lingering." We are not talking about some academic notion here but a fundamental change in what asset class will become more valuable, and what asset classes will diminish in value.
On the negative side will be the Pension Funds that will adversely affected by a prolonged period of low interest rates. It will also make it more difficult for retirees and senior citizens who depend upon their cash flows, to lead their lives. It may force both of these groups to make riskier bets to maintain their cash flows, their streams of income, and I expect just that to happen.
On the positive side are those people and institutions that borrow money as their costs of borrowing will not be going up. This will allow for increased corporate profits, more corporate equity buy-backs, and for lower mortgage and commercial loan rates. REITs, in my opinion, will gain from this new strategy and whether it is a single REIT or a closed-end fund of REITs, both classes of assets should benefit.
Even in a slowing economy, with questions about tariffs headlining the Press, lower interest rates may neutralize, or even more than off-set, these other issues. It has been 10 years since the financial crisis of 2008/2009 and the central bankers may finally have learned some lessons. The primary lesson here is that lower interest rates can drive economic expansion and that the Fed, as well as other global central banks, can totally control the level of interest rates, and hence borrowing costs, by the way that rates are handled.
Lower interest rates means more corporate expansion as the cost of expansion is not prohibitive. It means more buy-outs as the costs are affordable. It means more merger activity, as those borrowing costs do not block some deal. It also means that future borrowing costs may come down as bonds are rolled over and the credit markets tighten in to Treasuries.
For the government, with a rising amount of Treasuries to be auctioned, it also means that the amount that needs to be sold will have an off-set, which is a lower cost of funding. This will be a net positive for the American government, in my opinion, as the lowered cost of borrowing money stabilizes or overcomes the increasing need for money. It may be all a clever trick but it is one that we have seen work, during the last ten years.
For the American banks, if this program is instituted, it is a negative. Spreads between the cost of money for them and their ability to loan at higher yields will compress. It is not a disaster but it is something to consider when apprising both bank debt and equities.
If this new strategy does take place it is also a positive for the High Yield Market. Their cost of refinancing, or adding new debt, will be far less than what many people think now and the compression to Treasuries will give many companies, in this space, a welcome reprieve from a higher cost of funds. Here is another area to carefully consider, if the Fed changes their policy.
The Government should create, issue, and circulate all the currency and credits needed to satisfy the spending power of the Government and the buying power of consumers. By the adoption of these principles, the taxpayers will be saved immense sums of interest. Money will cease to be master and become the servant of humanity.
- Abraham Lincoln
"Immense sums of interest" may be saved here, if the Fed adopts these new principles. The key issue for investors is going to be who is going to be the beneficiaries. The assumed answers will no longer suffice.
Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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