In response to the Financial Crisis in 2008, our Federal Reserve lowered their short-term target interest rate to near zero. They also began a program labeled Quantitative Easing (QE). QE means that the Fed started buying Treasury Bonds and Mortgage Securities in massive amounts. This buying raised the price of these securities in the public market and the resulting higher prices of these securities with fixed dividends meant a lower interest rate relative to their now higher price. Therefore, the Fed’s QE program also lowered longer term interest rates to historic lows.
The Fed’s QE interference in the supply and demand equilibrium of free markets determining the natural rate of interest was highly stimulative to the economy in general, and especially to the price of stocks, bonds, and real estate.
The Fed’s massive buying of Treasury Bonds also gave our government the pretext to borrow massive amounts of money (new Treasury Bonds). The Federal Reserve bought these new issues with newly created money and removed them from the market keeping interest rates low.
Of course, Covid and the resulting Lockdown gave our government cover to spend and borrow even more.
This runaway government spending (Fiscal Deficits) resulted in inflation (CPI) rising to 6.5% last year. The Fed reacted and raised their short-term interest rate from near zero to 4.5% in a year. Of course, bond prices, which only offered the old low interest rate, declined significantly.
Unfortunately, this is where our nation’s regional banks had invested much of their customer’s deposits. So now, backing these deposits, were bonds that were worth far less.
But fortunately, most banks have been stress-tested, have proper risk management, and should be financially sound. Furthermore, there are many ways our government can cope with this. The upside of all this is that the Fed’s interest rate hikes should stop. The stock market sensing this has begun to rally.
As stated in our previous “Insights and Observations,” we at WST believe that progress will continue to happen in fits and starts, and markets will be volatile. In other words, while the short run has often proven difficult for markets, the long run has most often been met with success.
Know what you own, do not overinvest, and stick with quality.
-Cliff Jarvis