The Fed to Buy Longer-Term Government Bonds

The Fed had one of its regular meetings on Tuesday and Wednesday and the FOMC announced today that the Fed would be buying long-term treasuries, while selling an equal amount of short-term treasuries.  This should have no effect on the monetary base.  It is simply an exchange for longer-term government debt.

This move by the Fed is meant to lower the long-term interest rates.  By buying longer-term government bonds, this drives down the long-term rates.  The announcement today caused the yield on the 10-year treasuries to drop below 1.90%.  The mortgage rates are highly correlated with this interest rate, which means that mortgage rates are at or near all-time lows.

If you have procrastinated on refinancing your mortgage, you still have a chance to do so now.  If someone will lend you money for 4% interest over 30 years, why not take it?  With the massive debt and quantitative easing programs, we can expect for the dollar to be devalued.  Why not pay off your loan in depreciating dollars?

Today's action reinforces the power of the permanent portfolio as described in Harry Browne's book Fail Safe Investing.  The stock market tanked today and gold also fell substantially.  Bonds did well, which caused less of a down day for anyone investing to imitate the permanent portfolio.

There will come a day to speculate in the bond market (on the short side).  I have held off on recommending this speculation, and it is a good thing.  If the economy falls back into recession (if we ever left recession) and the velocity of money stays low to keep price inflation in check, then we could continue to see bonds do well as interest rates drop.  There are ways to short the government bond market (symbol: TBT), but we need to be patient.

This move by the Fed today just shows more desperation.  I didn't expect an announcement of QE3.  Perhaps the stock market did, since it dropped heavily this afternoon after the announcement.

The Fed will continue to support the banks (as it will also be buying mortgage-backed securities).  It will continue in its attempts to prop up housing prices and the economy in general.  It will do this in stages.  The free market is trying to liquidate the bad investments, but the Fed and the government are not letting this process take place.  We will continue to see this tampering by the Fed until it faces a scenario of massive price inflation.