This is a quick and dirty look at the Fed, easing, and interest rates. The meeting was a while ago so I am late with this one. I am tired of hearing about easing and interest rates though. I think people are making more of it than it is. The right stocks can survive the end of easing, and interest rates are not jumping to 5% after one FOMC meeting. This counts as a rant. I could be wrong, but easing was always going to end. The idea that people will just abandon the market, because easing ends seems foolish.
I am always amazed how the market seems to go insane whenever the Fed meets. I have mentioned before that quantitative easing is going to end eventually. If the market is this concerned it should structure its investments better. I am simplifying the issue, but it is actually the media. I hate how it makes so much news and the articles try to link cause and effect. At the last FOMC meeting the Fed said nothing. It only affirmed that easing would eventually end when the economy starts improving and unemployment falls.
Focus on the Reality of Interest Rates
That is not news, because that has always been the case. I am not even surprised that easing is expected to end or at least be reigned in around the end of 2013. The economic recovery will probably not go into full swing until 2015, but the beginnings will be 2014. That is enough griping about the Fed and their non-news, and the media making something out of nothing.
I do want to go over a little reality for the discerning mind. If you read my articles on Motley Fool (link up top) you know that I have discussed the risk from interest rates as it affects REITs, which I am mostly a fan of. Mortgage REITs are the most at risk from rising interest rates, and I am not too hot on these. However, the real problem that these mREITs face is the contracting spread. Increasing interest rates will depress the book value, but once the stock gets cheap enough it might be a good buy. If the spread increases there is more opportunity to make money for the companies and that could turnaround the falling dividends that have hurt mREITs. Yields are up, but only because share prices are down.
Once the stocks are cheap you take a position on the prospect of more income. Here is how the Fed is going to behave in the future. I cannot give you specific times, but the order of events is probably certain. First, either the Fed cuts back on its easing program, via bond buying, or it stops easing. This will be the earliest action the Fed takes as easing is the most contentious program. The Federal Reserve is better at tackling inflation than buoying the economy and easing is a way to help the economy along.
The Federal Reserve’s Path
Once easing stops the Fed will take it easy since the end of the cheap money flow will shake through the stock market and the economy. The Fed cannot take more action too early without risking the economic recovery. After the economy is pushing upwards on its own steam the Fed will use its traditional tools of the federal funds rate and the discount rate in order to increase interest rates. This will help moderate the economy and prevent it from rising too fast. The Fed will not be able to undo all of its easing and it will have to be very careful when it comes to economic growth. Only high levels of inflation will require drastic action. I will reiterate my point though, the United States Federal Reserve is equipped to deal with inflation better than anything else. Fears of apocalyptic inflation suggest a level of incompetence that I do not think is completely warranted. Do not get me wrong there is a lot of stupidity out there, but not that much.
Almost everyone is expecting a tough recovery and slow growth. That means that inflation will be manageable with slowly increasing interest rates. The Fed will manage this slowly. Think about this though. First the Fed needs to stop easing. Continuing easing but raising interest rates is completely foolish. The first step is to stop easing. Then interest rates can increase. The Fed will probably do this 1/4 of a percent at a time, unless economic growth is exceptionally robust (unlikely).
The end of easing will be a bit of a shock to the market, but anyone with a long-term outlook will be fine regarding this. You need to look at your portfolio and make sure you have companies that earned their valuations and are not hyped and artificially inflated. However, the interest rate risk has me far less concerned. It will be such a slow process to get to anything resembling a high interest rate if the recovery will be as slow as expected. For mREITs it could increase the spread even while interest rates remain relatively low. You cannot know exactly what is going to happen. Once easing stops, I think there will be more sanity.
The Other Side
The pit of the financial crisis is deep, and there has been a lot of stimulus from the government and the Fed. The loose monetary policy might eventually have major consequences. This is particularly true if something kicks off an economic boom. The tech boom, real estate boom, and others are examples of this. They become the engine of growth and have widespread effects for the rest of the economy. It could be anything next time. Another tech boom, or even an energy boom. Considering all the money already out there if economic growth occurs too fast inflation could be a problem. That would be the only thing that messes with the scenario I laid out above.