Friday, November 5, 2010

$600 billion in bonds for the economic recovery

My purpose to make one Million Euros in less than 5 years seems more than possible considering all the substancial factors that we are experiencing in the financial world today!

The Federal Reserve has now the power to revitalize the U.S. Economic recovery with a plan to pump $600 billion into the financial system, this move is designed to stimulate the economy in large part by lowering mortgage and other interest rates.

Although the approach carries significant risks for both the economy and the central bank's credibility, the steps announced by Fed policymakers could represent the nation's best hope for breaking free of sluggish growth, especially with bold initiatives unlikely from a newly divided Congress.

The Fed usually manages the economy by adjusting short-term interest rates. With those rates already near zero, Fed officials had to dust off a strategy for boosting the economy that debuted during the darkest days of the financial crisis. The Fed plans to create money, essentially out of thin air, and then pump it into the economy by buying Treasury bonds on the open market. These purchases are to be finished by the end of June.

Using this technique, called "quantitative easing," the Fed bought more than $1.7 trillion in securities during the financial crisis and in its immediate aftermath. The central bank's holdings jumped to their current level of $2.3 trillion, and the figure will approach $3 trillion when the new purchases are complete. This new wave of bond buying is a dramatic turnabout for an institution that just six months ago, amid a false spring in the economy, was weighing how it would begin unloading all the securities it had purchased.

The Fed action, will make it cheaper for Americans to take out mortgages and for businesses to borrow money to expand, all these events influenced the market even before the steps were formally unveiled. Average mortgage rates had already fallen from 4.5 percent for a 30-year fixed-rate loan over the summer, when Fed officials first said they were considering new steps, to 4.2 percent last week in USA the collateral effect was already visible in Finland with an average mortgage rate of lees than 3.5% for a 25- year fixed- rate loan (a perfect time to get a new appartment if you can get and manage a loan) .

The stock market, meanwhile, moved higher and the value of the dollar declined about 14% over the past two months in anticipation of the central bank's action.(here comes another temporary "market contradiction" How can we see a recovery with such a declined currency?

"This approach eased financial conditions in the past and, so far, looks to be effective again," Fed Chairman Ben S. Bernanke wrote in a Washington Post opinion article published Thursday. "Stock prices rose and long-term interest rates fell when investors began to anticipate this additional action. . . . Increased spending will lead to higher incomes and profits that, in a virtuous circle, will support economic expansion." I don´t quite agree with the second paragraph but I know I can play the game .

Mortgage and other interest rates could again decline in the coming months if the economy weakens and the Fed expands its purchases further. But those rates could just as easily increase if the economy starts picking up and the Fed ends its purchases as scheduled, or perhaps curtails them sooner. The action might also be suspended or scaled back if inflation spikes to dangerous levels.

Inflation is not the only risk that the Fed's initiative entails. It could cause new bubbles in the stock market or housing prices, if asset prices rise beyond what's justified by their fundamentals. Also, the value of the dollar could decline rapidly. We have the risks of future financial imbalances and an increase in long-term inflation expectations that could destabilize the economy.

Some analysts doubt the effectiveness of efforts to further reduce long-term interest rates, because they are already exceptionally low and credit, at least for larger companies, is easily available.

I really hope that all the Fed officials really know what they are doing, if they are playing with the economy with $600 billion in bonds it is feasible that knowing what I´m doing gets me just a Million €.

Fed officials viewed their move Wednesday as roughly equivalent to, in normal times, cutting their short-term interest rate target by three-quarters of a percentage point. That is enough to provide a real boost to growth but is not a shocking, unprecedented amount of monetary stimulus. And Fed officials framed their decision as being designed to fulfill its "dual mandate" to maintain maximum employment and stable prices. Now I wonder How helpfull was the idea of the economics nobel prize winners on this issue? employment and stable prices?

Have a good one, in the short term let's keep investing but the reasoning behind bonds is as follows:

A Bond is simply an 'IOU' in which an investor agrees to loan money to a company or government in exchange for a predetermined interest rate.

If a business wants to expand, one of its options is to borrow money from individual investors, pension funds, or mutual funds. The company issues bonds at various interest rates and sells them to the public. Investors purchase them with the understanding that the company will pay back their original principal (the amount the investor loaned to the company) plus any interest that is due by a set date (this is called the "maturity" date).

Bonds provide an element of stability that offsets some of the volatility of stocks. However, they are vulnerable to economic changes that can undermine their value.

The biggest economic threat to bonds is rising interest rates. If you own a bond and interest rates go up, the value of your bond on the open market, with few exceptions, will go down.

Of course, if you plan to hold the bond to maturity the value of your bond doesn’t change because interest rates change. You’ll still get the amount promise when you bought the bond, all other things being equal.

However, if you plan to own bonds for investment purposes - that is you buy and sell bonds as you would stocks - then interest rates are very important.

Bond prices move inversely to interest rates. When interest rates go up, bond prices go down and when interest rates go down, bond prices go up. Remember, we’re talking about previously issued bonds trading on the open market.

1 comment:

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