The most recent data released from the Federal Reserve's Open Market Committee meetings show that the Fed remains relatively positive, albeit cautious, about an economic recovery in the U.S. This means that the Fed can start planning to wind down some of its debt buying programs including the its current program to purchase $300 billion in Treasury debt.While the data was just released on Wednesday, the meetings actually took place on August 11th and 12th. But the results still merit scrutiny, especially for investors who may wonder what this could mean for their portfolios. Let's take a look.
First, why does the Fed buy treasuries? The Fed buys Treasury debt to try to bring down interest rates and to improve liquidity in the capital markets. When the Fed buys Treasury debt it increases demand for those securities. Typically, when demand for an asset increases so does its price. In this case, it is important to remember that when a bond's price increases its yield or 'interest rate' falls.
Over the last month Treasuries have enjoyed a nice bull market and as a result yields have been falling. However, what do you think will happen when the largest buyer in the market (the Fed) stops buying and starts planning to sell? The impact on prices could be significant.
A great way to visualize the impact of the Fed's buying activities in the treasury debt market is by looking at an exchange traded fund (ETF) such as the iShares Barclays 7-10 Year Treasury Fund (NYSE: IEF). The fund invests in treasury debt with seven to 10 years before maturity. The fund is up 1.5% over the last 30 days. It is even up nicely since the beginning of the financial crisis.
I think the Fed has been successful at keeping long term interest rates low by buying debt and injecting liquidity into the financial markets.
Of course, the Fed can't buy Treasury securities forever. When it stops, the impact of the change in strategy will be significant. The Fed has already announced plans to wrap up the $300 billion purchase plan by October.
To put this in some perspective, imagine what would happen if the largest institutional investor in a small stock stopped buying shares or worse, started selling them. How fast would the price of those shares decline? Could this happen to Treasury bonds?
A potential decline in bond prices matters to investors in popular bond ETFs such as IEF. But it also matters to stock investors. Assuming the Fed's actions reduce demand for bonds and remove liquidity from the market, this will drive yields up and increase the cost of capital for businesses. Increasing costs for businesses effects their bottom line, their earnings, and eventually their stock price.
Although in the long-term bonds usually fall in price as stocks go up, this normal relationship may be disrupted in the near term by the Fed's activity after October. Keep in mind that the U.S. Treasury itself will have to keep selling debt and increasing the supply in the market to fund the deficit.
How does this affect you? Essentially, if the increased supply from the Treasury and the declining demand and potential selling by the Fed drives down bond prices, yields and interest rates will probably rise. It's still very early in the recovery process. The concern is that interest rates could dampen corporate growth and stocks may flatten out or decline.
But this scenario also gives us plenty of opportunity as investors. Where bond ETFs fall, short traders (those who sell a stock hoping to buy it back later for a profit) make money. It is even possible to use bond ETFs that are inverse to bond prices. For example the Proshares Ultrashort 7-10 year Treasury ETF (NYSE: PST) is designed to return twice the inverse daily return of a 7-10 year treasury fund like IEF. Keep in mind, however, that FINRA has warned investors about using leveraged funds for anything but short-term positions.
For more conservative investors; when yields rise depositors get better returns and new Treasury bond purchases will come with a higher profit potential. A major shift in the balance between supply and demand in the Treasury market is not all bad news. Creating an investing plan to take advantage of those changes will make all the difference.
John Jagerson is a co-founder of Learning Markets.











Reader Comments (Page 1 of 2)
9-04-2009 @ 6:57PM
Yvonne said...
It never ceases to amaze me, how arrogant Politians can be.......the very thought that Obama would presume to address our School Children is abhorant. Where are you Americans that complain about everything.?? Get out and protest about this invastion of our Education System and our manipulation of the minds of our children. Are you all asleep? Druged, or drunk? Wake up...the alarm clock has been trying to get you out of your drugged sleep.... be aware of what is happening. The dumbing of Americans, socialism, and mind control. Do not live in HOPE, live in Faith that we can make our lives better///not with the Government nursing us, but with our own intelligence and hard work. Get up, get out, and get going!!!
9-04-2009 @ 9:49PM
DW said...
There is nothing wrong with the President speaking to school children about current events. If I remember correctly, Bush was in a classroom in Miami when the twin towers were attacked. What is O K for the goose is O K for the gander.
9-04-2009 @ 9:53PM
Iridium said...
Bush didn't use a propaganda film asking people to pledge allegiance to the president instead of the flag.
9-05-2009 @ 7:40AM
Dan Barnett said...
All the above are relevant to bond prices how? Though as long as Iriduim gets his "news" from Rush Limbaugh, we'll continue to see his baseless assertions. I'd always thought that "Faith, Hope, and Charity" went as a trio and you couldn't drop out any of them. Well, serves me right for sleeping through Sunday School.
More to point. Admittedly nothing lasts forever, but as long as the recovery is in it's initial stages and job losses continue, I'll bet & invest on the basis on low interest rates.
9-05-2009 @ 9:35AM
Zebra365 said...
I think that if the Fed announces it will buy no more Treasury Bonds then prices will dive and interest rates will soar. The negative effect of higher rates on business and the markets will cause Bernanke to lose his nerve and go back to buying Treasuries (monetizing debt).
The release of IMF special drawing rights (SDR's) on September 9 will be the world telling the US that they will no longer support the dollar as the world reserve currency. Just this last week the Chinese bought $50 billion of these SDR's when the could have bought Treasuries.
Next week the Treasury will borrow over $125 billion, a new weekly record. The US Treasury is sucking up the liquidity in the world more than any other country. This lack of liquidity will guarantee a slower recovery worldwide.
9-05-2009 @ 2:49PM
JP Morgan's ghost said...
When the FED buys Treasuries it's just a shell game as the FED prints the dollar, charges us through the IRS a fee and controlls all the money, credit, interest rates and the "Treasury" and "government". They are buying "Treasuries" because no-one else will. America is 100 TRILLION in the hole which is more money than the entire planet has ever seen-then we have to pay interest on that? A chart of the money supply shows they ran the printing presses overtime and flooded not the people but the banksters with trillions and the effect has not yet been felt. Once this paper floods out into the "system" you will experience inflation and the dollar will drop and interest rates will have to soar. Experienced this down in Brazil working at GM back in the late 80's. Currrency collapse(two of them). Big risk the dollar will become toilet paper with these idiots running the show-bankster gangsters. They are globalists who backed Communist China and India so this might be what they want, to bust this country down into their global financial sysytem and a new global currency. I like gold, silver, oil, copper, steel, real things even agriculture and water.
9-05-2009 @ 1:13PM
debo said...
The fed should never have never bought these bonds in the first place.(WITH PRINTED MONEY FROM THIN AIR). China has stopped buying them and are now buying from the IMF. Why because china knows they are worthless and that the Us can not pay back the debt, they will default. They have also pulled all there GOLD from England banks into their own. The Chinese knows what is coming, yes the collapse of the dollar. They have also told their people to but GOLD. Russia, Brazil, India and other countries have followed suit.
9-05-2009 @ 2:51PM
clem591 said...
why is it i can't figure out what branch of our goverment THE FEDERAL RESERVE belongs to?>>when was the last time our treasury pinted currency?>>what event happened shortly after the treasury started printing money?>>>why did the treasury stop printting currency?>>>what has the greater value 1 a federal reserve note or 2 a treasury note?
9-05-2009 @ 2:59PM
clem591 said...
what would happen if we fired the federal reserve? it seems that china is owed big bucks not from america but a private bank called the federal reserve. in the end things will work out we can print our own dollars and send those worthles federal reserve notes to china lol
9-05-2009 @ 3:26PM
txtreeman said...
At 3.5 trillion, the interest on the national debt becomes self perpetuating...you pay interest and never pay down the principle. We are at what, 7 trillion heading for 11 trillion in debt? The country is broke, run by corrupt politicians who don't seem to understand rudimentary business principals. Am I missing something or are we screwed?
9-05-2009 @ 5:12PM
catherine pierce said...
join the movement: auditthefed.com
9-05-2009 @ 6:59PM
docandmillie said...
I'm curious what happens to the parents and children that don't attend school? Think about it, Schools will have attendance records for the no shows of children forever. Your thoughts and opinion of the President will no longer be private. This will affect everyone for a long time to come. The anti-Obamas, anti-Socialist and the anti-global warming parents will have nowhere to hide. The children will be targets for indoctrination in the short and long term, the money can be focused on those that resist government control. Think about it, you have 3 types of school children. First, those parents and children that support the government currently in power. Second type, are the parents and children that don't care about politics. Which is ok for the government, its like sheep being herded to the slaughter house. Or in this case, school house. 3rd type, Are parents and children that are informed, listen to AM talk radio, Fox news, tea party goers, patriots or a political activist. They will know you by name and persecute these people, the AM radio towers are come down already, look it up. They just started destroying the towers this weekend, Soon all communication towers will be destroyed. As we speak the age of information is near its end.
9-05-2009 @ 10:25PM
Patricia said...
Where can I find the am radio towers are coming down
I have searched the net and can not find it can you help me thank you I know Acorn started buying up all the radio stations with the money that was allocated to it from our tax money from Obama???
9-06-2009 @ 9:10PM
youngmike1345 said...
The current congress will repeat history.
Unemployed and loving it-no slave-no more
Mike Young
9-06-2009 @ 9:19AM
JoJo said...
Hers is an idea ..End the Stinking FED !! these banksters and ther crones ned to go. I would be willing to cut my losses now for the better times to come later.
9-06-2009 @ 10:09AM
john said...
We will soon see stagflation where jobs are scarce and prices are high. These games the government plays with one agency, The Treasury. selling it's debt to another agency The Fed, of course cannot go on forever. Furthermore, when the Chinese start producing for their own markets and no longer need the American market they wil stop financing American debt then it's all over for the American economy; unless, of course, we bring those jobs back and start producing real things instead of paper products like the various financial instruments which reallly are not worth the paper they are printed on.
9-06-2009 @ 2:49PM
clem591 said...
better times are ahead, with dingdongs on the right and lunies on the left the middle is growing, we now control who is elected, and soon we will have our own un stopable middle of the raod party. the fedreal reserve can be fired, which will happen. we will return to the good times where it only tales one wage earner in a family. minimum wage will be indexed to the enegy price, bringing the cost of goods down
9-06-2009 @ 7:13PM
dewdrop said...
please request bloggers to add their qualiifications like Harvard Yale Princeton etc.
9-07-2009 @ 11:41AM
clares said...
FYI, you folks so outraged at Obama trying to encourage our students: Ronnie R, your hero, did the same thing. So do some homework before you judge, boys and girls.
9-07-2009 @ 11:52AM
Tech said...
This country is run by the private FED oil banksters who are desperate. Long headed by geezer gangsters who never worked a day in their spoiled elite lives like David Rockefeller who heads the Council on Foreign Relations, the Trilateral Commision, Council of the America's, the Bilderburg Group, Rockefeller Foundation, etc. and had Cheney as former director at CFR and Obama's chief foreign policy advisor as co-founder of his Trilateral Commision. They want CONTROL and are desperately afraid of losing it and their money which IS the FED. Back in 1911 John D.Rockefeller's Standard Oil was broken up as he was the most hated man in America and a total gangster who operated a terror network to seize 90% of the oil business. In 1913 the robber barons having financed Wilson's campaign had him sign the FED/IRS scam which gave them complete control over all the money and through the IRS forced us to pay them a fee for it. Your Federal Taxes are collected by the IRS but the money goes into their private banks and bankers see human beings as a cost on their balance sheets-a liablity-that's you. JP Morgan realized he could control the media by simply buying into all the major papers to control their editorial staffs. Since then a small group of people have controlled the nation and played us with wars, taxes, booms and busts, and market manipulations also seizing the major corporations. They created the CIA from the OSS which ran right out of their offices in NYC. Set up the cold war, Vietnam, profited from both sides in WW11, and make money moving markets either up or down.(makes no difference to them as long as they move) Globalist banksters who backed Communist China's rise and have us as cannon fodder to control the Caspian and middle eastern oil fields. However they gave China and BP the best oil pool in Iraq and the Caspian gas will be piped to India's booming economy cutting out the Russians and Iran. Their ultimate goal is global domination and control and this involves breaking the United States down and I would assume the dollar although I don't know what their exact timetable is.(not sure they do either) As long as they can keep the majority from knowing about them and who they are they can operate and pull this off. 99.99% of the people on earth haven't a clue. Kennedy tried to stop them as he was a proud nationlist and American but they blew out his brains and his brother's and killed his son so it's hard to see how they could be stopped. Just gangsters and the 911 BS, anthrax, killing of Senator Paul Wellstone, Patriot Act, TSA, Homeland Security, NSA, CIA, FEMA, etc. are just to control the people while they bust us down and fleece us.(stole over 24 trillion in the last year) Most folks are just kept too busy trying to survive they never have time to think or figure them out. Trade technically following the trends up and down and the dollar has been backed by oil since 1971-Nixon. Gold, oil, commodities generally trade opposite and when the full effects of the massive printing of dollars to the banks hits the dollar will sink against them.
Oh, I have been all over the world, worked for NCS bought by Pearson Plc(operates in 64 countries), GM down in Brazil, Lockheed Martin, Adage, CGX, etc. and my father had David Rockefeller in a "class" at Colombia. We're screwed. NCS and Pearson set up the TSA under Homeland Security, No Child Left Behind, etc. and through Akin&Gump installed Bush/Cheney 2000 and their "program" that followed. Control is what they are all about.