Monday, November 15, 2010

They Just Don't Get the Fed

No one gets the Fed. Everyone is confused. Everyone is upset. And NO ONE gets it.

Not too long ago the Federal Reserve, which is NOT the government by the way, announced that they are embarking on a cruise, the QE2. Ok, ok, it's not really a cruise line, it's an abbreviation for Quantitative Easing, Round 2. It means that the Federal Reserve, a private corporation, is going to buy US Treasuries...and we at MOFinancial say THANK THE HEAVENS.

Lets give you a little background on the situation. For more, you can check out our older post entitled "Bail on your Bonds". Inflation is coming...seriously, it's coming. Look at food and energy prices and you'll see that inflation is upon us. You know what loves inflation? Stocks. Do you know what hates inflation? Bonds.

It's a simple: When interest rates go up (they're at zero now...sooooo, you tell me a situation in which the next rate hike isn't up), then bond prices go down. Bonds always trade with market interest rates (outside of the inefficiencies that exist in the markets temporarily). When a bond doesn't have a market interest rate, the price will decline until it reaches a market interest rate. So, as the Feds eventually raise rates to head inflation off at the gap...bonds are going to get WHACKED!

Now, here is the genius of the Fed. What's the one way NOT to lose money on bonds? That's right, hold them until maturity. Given the average age of a bond buyer (somewhere in the 50s or 60s) because of the asset class being viewed as "safe" and "conservative" , it is unlikely that these investors will even LIVE to maturity...let alone hold the asset until maturity (if they're holding 30 year bonds). When they pass away, the funds will be liquidated by eager beneficiaries who will realize what should be massive losses at that point thanks to a higher federal funds rate & inflation (which will destroy the principle value of those bonds).

Another problem? Do you really think investors will hold treasuries of the 10 & 30 year variety when they start going down as rates go up? Heck no! No bond fund manager is going to stand around and watch their fund price get hit week after week...they'll lose their jobs. Thanks to an inflow of $16 Billion Dollars last year, those guys have a lot of firepower these days to do massive damage by hitting the sell button. It'll be like yelling fire in a crowded movie theatre & watching everyone hit the door at the same time. When individual investors see what the institutional seller is doing to the price...they'll jump in and hit the panic button along with them.

What is the solution? Just take a quick look at QE2. Ben has $600 Billion in firepower to go out and buy treasuries that are floating around out there. That is enough to buy up every penny of the $16 Billion that flowed into the individual investor held Mutual Funds last year PLUS some. This gives individual investors a "buyer of last resort" to offload their treasury holdings so that they can swap into smarter investments like clean corporate debt, high yield bond ETFs, Emerging Market Sovereign Debt, REITs, and high yielding equities. All of which are better choices right now than the long end of the treasury curve...heck, better than the short end because of low yields. Because the Federal Reserve is an institution and not an individual, they can afford to hold the bonds to maturity without giving a darn about the principle since they'll collect that bond interest the entire time & will be made whole at maturity. Heck, they may even take the interest & go buy some real assets like corporate debt (which would be a terrific idea when bonds get hit as they raise the fed funds rate).

So to all you holders of Treasuries out there...individuals, PIMCO, China, everyone...go sell your US Government to the Fed because Ben is buying. You can thank him later for saving your rear end, and your retirement savings. We'll probably get some inflation out of all this...which means Ben will make your 401(k), IRA, and even your house go up in value...not a bad days work for a guy who no one but Jim Cramer seems to understand. We're with you Jim, Ben may just be the man of the Century after being Time's Man of the Year. So to Ben & the Fed leaving on the QE2...BON VOYAGE from Magnum Opus Financial!


  1. I totally agree with the fact that people dont see the feds action as an opportunity to get out of those bad paying papers and get into something better. The market is offering great companies with high dividend yields much better paid than those bonds. I also consider that inflation is a concept people misunderstand because the fact that the fed is injecting money into the system does not necessary implies that there will be inflation. So i totally see why you and Cramer are saying bless "Ben".
    BTW liked the article

  2. Anyone who supports a private bank who controls what our money supply should be should be considered a traitor to this country. Our Ira and house values will go up? BIG WHOPPIE DOO, how about energy prices, food prices, healtcare prices, taxes tuition, insurance, have you taken a look at those costs????? Also, if you are smart, ask yourself this, why should house prices go up, when there is no demand and no buyers? Just another gov prop up? Get out of the way, let the price come down to what the buyer is willing to pay for it. All you have to do is support funding to people with jobs and docs.