What is the Fed Going to do With its Bonds and Today’s Other Top Stories

Yesterday the Federal Reserve announced that it would stop buying bonds as part of its economic stimulus package known as Quantitative Easing.

Over a six year period, the Fed bought over $3 trillion dollars of mortgage and U.S. treasury bonds from banks and hedge funds in an effort to keep interest rates at zero.

Wednesday’s announcement means that markets will now focus on the timing of the first interest rate rise, but according to Heidi Moore from the Guardian, that’s not the big question for investors. “Of course interest rates will rise; they’re currently at zero.” Moore says.

The real question is, what are the Fed going to do with the enormous number of bonds which it bought?

More from Heidi Moore:

The Fed’s balance sheet – a measure of what it holds – was under $1tn when it started buying bonds through QE. Now its balance sheet is over $4tn.

That means, over the next few years, to get back to normal, the Fed has to find a way to sell over $3tn worth of bonds. The likely buyers? The same group of banks and hedge funds that first sold them to the Fed.

There are three ways the Fed will continue to pay banks higher interest rates. All of them center around controlling bank “reserves,” or the money they keep parked with the Fed.

The first two have to do with all the money that banks have been parking with the Fed. Banks have not been making loans with that money as they should have been. QE made it too profitable to keep the money sitting at the Fed. The Fed will continue to pay the banks high interest rates to keep the flood of money at bay. It will also offer the banks a higher interest rate to keep those deposits locked up for a certain period of time – like a certificate of deposit, but for major financial institutions.

Another way banks will benefit: what’s called “reverse repos.” The upshot is that the Fed will borrow from banks temporarily, then pay them back with interest the next day. The banks make good money on the interest – and even better money because it’s clear that the Fed plans to do many more of these deals. In September the Fed increased the cap on such deals to $30bn per bank – triple the previous $10bn limit.


Todays Other Top Stories

Learn Bonds

Learn Bonds: – Round three of quantitative easing is over – Did it make any difference? – Well, round three of Quantitative Easing is over. The monetary policy in the United States that has dominated the world for the past several years is done. Question is did it make a difference?


Municipal Bonds

MarketWatch: – This shunned investment is actually among the safest today. – Conservative investors need good yields. They need protection from higher taxes. And they need to know their principal is safe in a chaotic world.

Bloomberg: – Oregon to vote on bonds for college-aid endowment. – Oregon voters will decide Nov. 4 whether to let the state sell bonds to create a first-of-its-kind endowment to boost financial aid for college students.

Bloomberg: – Riskiest WTC debt from $1.6 billion muni offer gains after sale. – The riskiest part of this week’s $1.6 billion tax-exempt bond sale to finance the construction of 3 World Trade Center is rallying, driving yields down more than 1 percentage point.


Bond Market

Benzinga: – QE is over; bull bond market likely isn’t. – The Fed has not completely withdrawn its support of the bond market. In fact, it will continue to buy bonds. Today’s announcement just signals the end of printing money to make these purchases. By pledging to maintain its balance sheet of treasuries and mortgages at $4.5 trillion dollars the Fed is committing to replace its maturing bonds by purchasing new issue from the Treasury during its auctions.


Treasury Bonds

Market Realist: – What the 30-year TIPS auction says about inflation expectations. – How volatility means bumpier trading for everyone else.

CNBC: – Treasury Department auctioned $29 billion of 7-year notes at a high yield of 2.018%. – Bond yields sank to session lows after a report showed U.S. growth was boosted in the third quarter by a surge in defense spending and a narrower trade deficit. A separate reading showed first-time claims for state unemployment benefits rose.

Reuters: – Prices up on Europe fears; long end gains after Fed statement. – U.S. Treasury debt prices rose on Thursday after falling for two straight sessions as worries about deflation in the euro zone prompted investors to seek safety in government debt.


High Yield Bonds

Businessweek: – Charter sells $3.5 billion of bonds to buy Comcast assets. – A unit of Charter Communications Inc. (CHTR:US) sold $3.5 billion of speculative-grade (BUHY) bonds to help acquire some of Comcast Corp.’s cable subscribers, more than doubling the amount it initially planned to issue.


Emerging Markets

Businessweek: – Venezuela quelling default talk spurs bond surge. – Venezuela is rewarding bond investors with their biggest gains in five years as it quells default speculation. To Stone Harbor Investment Partners LP and Barclays Plc, the rally has just started.


Investment Strategy

Market Realist: – Why you should stick with U.S. large caps and high yield. Within the United States, I recognize opportunities, particularly in large cap, cyclical names. On the fixed income side, high yield now represents an attractive option given recent spread widening.

Business Standard: – Inflation linked bond funds have limited utility. – They are suitable only for very conservative investors and currently other debt funds give better returns.

FT Adviser: – Alternatives to strategic bond funds. – Advisers could consider using absolute return funds, although these may be even more fraught with difficulty.

Alpha Architect: – Predicting bonds with stocks: A strategy to improve timing in corporate and high yield bonds. – The equity market can lead corporate bond returns by up to one month. I have explored this concept before on the premise that there is a logical linkage between stocks and corporate bonds (and high yield) since they share vulnerability to common economic factors (growth, credit risk etc). Since stocks are far more liquid than corporate or high yield bonds, it makes sense that the stock market should have a leading signal.


Bond Funds

Bloomberg: – These strips tease ETF investors. – Two exchange-traded funds with “Treasury” in their names are running circles around other bond ETFs. The Pimco 25+ Year Zero US Treasury Index Exchange-Traded Fund (ZROZ) and the Vanguard Extended Duration Treasury ETF (EDV) are up 35 percent and 33 percent this year. That’s more than 10 percentage points above the bond ETF holding third place, the iShares 20+ Year Treasury Bond ETF (TLT). How on earth do you get returns like those with Treasuries?

Morningstar: – 3 fund managers that earn their fee. – Many active fund managers fail to deliver on their promises, and their higher fees erode dismal performance further. But these three managers earn their slice with outperformance.

Zacks: – Unconstrained bond funds enjoy surging popularity. – The low-interest environment has been pushing unconstrained bond funds’ popularity. The interest rate risk is often mitigated by fixed income strategies, and unconstrained bond funds capture this fixed income return strategy pretty well.

ETF.com: – Demand for bond ETFs picks up in October. – Investors have poured more than $21 billion into U.S.-listed ETFs so far in October, showing a strong preference for U.S. fixed-income exposure above all other asset classes. The demand for the safety of bonds came in a month when stock market volatility shot up, and the S&P 500 remained largely unchanged, with gains of only 0.5 percent.


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