Financial markets rallied on the news that the Federal Reserve will not "taper" and instead will keep buying $85 billion a month in mortgage and Treasury bonds until central bankers see more job creation.
In this conversation, Bankrate's senior financial analyst, Greg McBride, CFA, and its Washington bureau chief, Mark Hamrick, discuss the market's addiction to the Fed's quantitative easing program, likened to performance-enhancing drugs. And how long will the respite in mortgage rates last?
FED UPDATE: Enjoy the punch, but watch for the hangover
Is QE3 like performance-enhancing drugs or booze? And how long will the respite last in mortgage rates? Bankrate's experts discuss.
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Mark Hamrick: From Bankrate.com, this is Special Report, the Federal Reserve's September meeting. Hello, I'm Mark Hamrick, Washington Bureau Chief for Bankrate. After months of anticipation among investors, savers, borrowers and consumers, the Federal Reserve has wrapped up a two-day policy-setting session. And in doing so, said that it will continue buying assets aimed at encouraging economic growth. That was a surprise to some in the financial markets that thought the Fed might begin to slow those asset purchases.
We're going to talk about all this now with our senior financial analyst, Greg McBride. Greg, I think in many ways the proverbial handwriting was on the wall with this when earlier this month we had the unemployment rate reported at 7.3 percent, and the only reason the unemployment rate went down is because people gave up looking for work. I know it's a lot more complex than that. I'm going to ask you one question that has more to do with the markets than really what the Fed was doing. That is, why do you think the markets rallied so? Is it because the Fed is continuing to provide performance-enhancing drugs to the economy?
Greg McBride: That's exactly right. The market is addicted to that stimulus, and the Fed has said "Hey look, we're not any closer to taking away the punch bowl." And you know, a lot of people had been expecting that they would start to wean markets off of that stimulus beginning this month. What they said today is "No, we're not quite ready yet." As you see, markets have responded to that very favorably.
Mark Hamrick: So we need to break this down for people who may not be aware that mortgage interest rates really kind of spiked over the summer, rising as much as 1 full percentage point. We've seen some relief from that. Do you think that is sustainable, meaning the relief is sustainable?
Greg McBride: Not unless the economy runs off the rails. I think, if anything, this is a respite in the sense that this keeps a lid on mortgage rates. But the tapering is inevitable. When the Fed does inevitably start to dial back that stimulus, whether it comes at the October meeting or later on this year or early in 2014, whenever that happens, we're going to see mortgage rates start to work their way higher. But, in the meantime, this stimulus … maintaining at the same pace, I think keeps a lid on mortgage rates and gives people a brief pause where they don't have to worry about rates running away from them.
Mark Hamrick: So to the extent that Chairmen (Ben) Bernanke indicated earlier this year that the so-called tapering could begin sooner rather than later, and now it seems as if it's not quite so soon. Does that mean that individuals who are dependent on lower interest rates should try to take advantage of the rates they're seeing right now, ASAP?
Greg McBride: Well, I don't think you have that urgency when it comes to things like car loans, home equity lines and credit cards simply because these are tied much more closely to short-term rates and the Fed has been very clear that their time table for adjusting the federal funds rate -- the benchmark for those short-term rates -- hasn't changed. We're still looking in all likelihood at some time in 2015. But I think there's a little bit more urgency on the mortgage side in the sense that we have seen a big runup in rates over the summer in anticipation of the tapering. And while we do get a little bit of a pause to catch our breath now while they postpone the tapering, when that tapering comes, we're going to continue to see mortgage rates move higher provided the economy continues to improve.
Mark Hamrick: So really it's important to underscore this because you made a great point there Greg. For most people, the most sensitivity to what the Fed is doing really relates to mortgage rates if indeed they have something that's associated with that. Of course the stock market is doing well, so that's important, too.
Greg McBride: Yeah, absolutely, 401(k) and mortgage rates. Those are really the two household impacts here. Yes we've seen a big runup in mortgage rates, but we've also seen a big runup in the stock market. I think the other point of caution here is that look, the faster we go up, the further we're going to fall once the Fed starts to take away the stimulus. It's important for people to expect that, (and) not to panic when it happens. It's par for the course at a point when we're talking about the Fed taking away stimulus. For now, the party continues, but the hangover is going to be that much more difficult.
Mark Hamrick: And of course when we're saying that the market could fall, what we're really saying I think, right Greg, is that you know you might have a 10 percent correction if not more at any time. So just don't be shocked by that.
Greg McBride: Exactly. We're talking about giving back some of the gains that we've seen. I think you know just specifically, I think we're due for a 10 to 15 (percent) and maybe even as much as a 20 percent correction. But I'll go out on a limb and say that a year from now the market is going to be higher than it is today. It's just not going to be a straight line between now and then. We are going to have some volatility.
Mark Hamrick: So we began talking about how the jet fuel that the Fed has been applying to the economy in this round of so-called quantitative easing has now lasted for about a year. It's been interesting, Greg, because Chairmen Bernanke, among others on the Fed, have acknowledged that there could be some unintended consequences from engaging in this. And, the longer they do it, one has to think that the greater the risks are because if it causes risk while you're doing it for a year, it causes further risk doing it another year, right?
Greg McBride: Absolutely. I think you have to look at the unintended consequences. Right now, at the current pace, the Fed is monetizing about 80 (percent) to 85 percent of the U.S. federal budget deficit this year. That is not a sustainable condition. You also have the longer-term worry about with the Fed printing all this money, at what point are we going to have to contend with inflation? Just because the numbers are low now, doesn't mean they're going to stay that way forever. Those risks grow the longer the stimulus continues at this pace.
Mark Hamrick: Greg, what else do you think people need to be aware of by virtue of what the Fed is or isn't doing right now?
Greg McBride: All they've done is really kind of buy themselves a little bit more time to see how the economy is doing, particularly with the budget debate and the debt ceiling wrangling still head of us. We get to the end of October, if both of those issues have been put behind us and you know the economy continues to show improvement, then I think the odds of them tapering at that point go up. If not, it's really going to be kind of a meeting to meeting thing, much like that baseball player who is day-to-day.
Mark Hamrick: Very good Greg. We've been speaking with Bankrate's senior financial analyst. Greg, thank you.
Greg McBride: Thank you, Mark.
Mark Hamrick: You've been listening to Special Report from Bankrate. Our editor in chief is Julie Bandy, managing editor Katie Doyle, assistant managing editor Holden Lewis, and thanks to our producer Lucas Wysocki for his work in the studio. For more on the Federal Reserve and other issues relating to personal finance, visit Bankrate.com. And you can follow us on Twitter @Bankrate. Also, catch our week podcast, Your Money This Week -- free downloads from Bankrate.com and iTunes. I'm Mark Hamrick. Thanks for listening.