Wednesday, March 20, 2013

The Fed and Financial Repression ... Don't Own Bonds

The Federal Reserve intends to keep interest rates low for at least two more years.

And that's where the term 'financial repression,' boring as it sounds, needs to be understood by all individual investors. In essence financial repression takes place when government's policy is to reduce its debt levels in real inflation adjusted terms by paying less interest on its borrowings than a free market would dictate. In simple terms, interest rates are kept below the rate of inflation, thus causing a 'real' loss to owners of bonds and other fixed income instruments.

Thus, we can expect that interest rates as a matter of policy will remain below expected inflation over the next several years, thus making money saved worth less and less than its original value as time goes by. And that's in a nutshell why owning bonds is not a good idea for individual investors.

{NOTE: For a good description of how financial repression works, just bing or google the term. It's worth taking a few minutes of your time to understand it fully.}

In any event, Fed Maintains Rates and Strategy has the story about the Fed's two day meeting which concluded Wednesday afternoon:

"The Federal Reserve produced no surprises on Wednesday, affirming that it would plow ahead with its efforts to stimulate the economy even as it hailed “a return to moderate economic growth following a pause late last year.”
The Fed under its chairman, Ben S. Bernanke, has made clear that it regards its program of low interest rates and large asset purchases as necessary for the economy to keep growing fast enough to return unemployment to normal levels.
In a statement issued after a two-day meeting of its policy-making committee, the Fed reiterated that it would continue to hold short-term interest rates near zero at least until the unemployment rate falls below 6.5 percent, which forecasters expect no sooner than 2015. The February unemployment rate was 7.7 percent. . . . 
“The committee continues to see downside risks to the economic outlook,” the statement said....       
The Fed separately released economic forecasts by 19 of its senior officials showing a slight strengthening in the consensus view that the central bank will need to suppress short-term interest rates for several more years. While a majority of the officials continued to predict that the Fed would begin to raise its benchmark interest rate by the end of 2015, the average predicted rate declined slightly as a number of officials shifted forecasts downward.
In keeping with that shift, the officials’ expectations for the economy soured slightly. They predicted that the economy would expand between 2.3 and 2.8 percent this year, down from their December forecast of growth between 2.3 and 3 percent. The consensus forecast for 2014 also fell. Officials now expect growth between 2.9 and 3.4 percent in 2014, compared to a December forecast of growth between 3 and 3.5 percent.
Concerns about inflation remained in abeyance. Fed officials do not expect inflation above 2 percent over the next three years, well below their self-imposed ceiling of 2.5 percent inflation. They forecast slightly less inflation during the current year and slightly more by 2015, as compared with their December projections.
At the same time, officials were modestly more optimistic about job growth. They predicted that the unemployment rate would rest between 6.7 and 7 percent at the end of 2014. In December they had predicted that the rate would sit between 6.8 and 7.3 percent at the end of 2014."
Summing Up       
The government is borrowing trillions of dollars at historically low interest rates, and a big part of the reason is due to the financial repression measures implemented by the Fed to help get the economy back on solid ground.
The Fed policy and resulting low interest rate scenario is not likely to change for at least several more years. Financially repressive interest rates are the way the government plans to reduce its inflation adjusted debt levels over time.
And since getting the general economy and housing back on their feet will still take some considerable time, the Fed's post-meeting commentary Wednesday afternoon reaffirmed that short term interest rates will remain low indefinitely.
Thus, the advice for individual investors is simple. Don't fight the Fed and don't be a lender by buying bonds or other fixed income instruments.
This is a once in several decades situation, and individuals should not be caught doing what used to make sense but no longer does. Owning bonds, that is.
And that's because of one simple reason. Bonds won't any time soon protect an individual's purchasing power, let alone generate real inflation adjusted returns on the money invested.
That's my take.
Thanks. Bob.

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