The Federal Open Market Committee (FOMC) will not raise interest rates, but indicated they will begin unwinding their balance sheet starting in October of this year. Also, they are expecting a rate increase at December’s meeting. As of now, the market is predicting a 60% chance of a rate increase at that meeting. As of two days ago, there was a 50% probability of such action. A quick review of FOMC action since the Great Recession will help provide some context on the situation and the significance of their decision to unwind the $4.4 Trillion balance sheet.
From DRS 2015 Economic & Market Update, It’s All About the Numbers:
In response to the Financial Crisis of 2007/2008, a coordinated effort by developed countries’ central banks flooded the major economies of the world with excess liquidity in order to drive down interest rates. The plan was enacted to restore stability and confidence in the markets and revive economic growth.
Signs of a complete system failure began in 2007 when the mortgage market collapsed. Then in March 2008 Bear Stearns, an 85 year old company that was the fifth largest investment bank in the world, went from a supposedly healthy state to being auctioned off to JP Morgan Chase in a last ditch effort to avoid bankruptcy. In September of 2008, the US Treasury seized control of Freddie Mae and Freddie Mac. The two quasi- governmental companies required $200 billion in capital injections due to losses from mortgage defaults. A week later, AIG was bailed out in the amount of $85 billion. Next, Lehman Brothers was forced into bankruptcy because the financing needed to provide financial support, dried up. From that point, the mortgage market completely collapsed alongside some of the largest financial companies in the world. The world’s markets were thrown into turmoil as credit markets froze due to a spike in fear and a lack of confidence. The Treasury and the Federal Reserve were called upon to devise a bailout plan to restore the function and the confidence in the markets by stepping in as the “lender of last resort”. Fortunately, the actions taken by the Treasury, the Federal Reserve and signed into law by President Bush staved off a complete collapse in the markets. The events of 2007 and 2008 represented the worst economic downturn since the Great Depression.
Months later, the markets were still in turmoil over the near collapse of the entire system. The FOMC had already dropped the federal funds rate to zero percent and the committee had used all of their other conventional tools to arrest the markets’ slide. That is when the FOMC unveiled its first Quantitative Easing (QE) since the Great Depression; a package of $800 billion to buy bonds to bolster lending and to support the flailing housing market. The initial policy response was considered massive in scale but a follow up response, just a few months later, would bring the program total into the trillions of dollars.
Since the end of Quantitative Easing in October of 2014, the FOMC has been reinvesting the proceeds from bonds that matured into new bonds. While it was not considered “QE”, it has had a significant impact on liquidity in the markets due to its size of $50 Billion per month. As of today’s announcement, the FOMC intends to stop reinvesting the proceeds and begin reducing the remaining bond holdings irrespective of economic data. It remains to be seen whether such a historically data dependent FOMC will all of a sudden shift gears and not consider the economic environment and resulting implications of their actions.
At DeCesare Retirement Specialists we prioritize safety of capital above growth opportunity during volatile times. We continue to employ counter risk measures alongside a prudent growth strategy in order to protect capital in what continues to present as a challenging economic and investment environment.
Should you have any questions and/or concerns about your accounts with us or outside of our management, please call me at 856.235.3830 or email me at Steve@DeCesareRetirement.com.
