Less Liquidity=More Losses
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Jun
20
Jonathan Yates
Less Liquidity=More Losses
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The Dow Jones Industrial Average fell more than 350 points today as global exchanges continued plunging after the comments of Federal Reserve Chairman Ben Bernanke about the ending of Quantitative Easing III.  The chart below shows how the Dow (NYSE: DIA) and Standard & Poor’s 500 Index (NYSE:SPY) have cratered in recent trading.

 

Announced last September, Quantitative Easing III consists of the Federal Reserve expanding its balance sheet to acquire $85 billion monthly in Treasury Bonds and mortgage-backed securities.  This is needed to finance the US budget deficit so that low interest rates can be maintained.  There is no enough demand presently for these securities at yields low enough to keep interest rates down in the United States.

Low interest rates in the United States are critical for its continuing recovery from The Great Recession.

The first sector this is designed to help is housing.  Low interest rates keep mortgage rates suppressed.  That makes it easier for buyers to purchase a house.  As about one-sixth of the US economy hinges on the real estate sector, a rebound in housing is vital for the American economy to recover.

The equity markets also benefit from low interest rates.  Investors will buy stocks when bond yields are so low.  The positive reasons for this are that the stock market offers better alternatives.  Negative factors are the concern that bonds will tumble when interest rates rise.

That has been happening in recent market action.

Concern has been developing that the Federal Reserve would pull back its bond buying.  Comments from Bernanke and others from the Federal Reserve, such as Kansas City Federal Reserve President Esther George about the American economy improving so much that Quantitative Easing III will no longer be needed just to not fit with the huge budget deficit of the United States.

Quantitative easing measures have been needed as no investors, foreign or domestic, were willing to buy Treasury Bonds at such low yields.  They still are not, particularly with the US budget deficit close to $700 billion.  More than likely, Federal Reserve officials led by Bernanke will begin a campaign to “talk up” the US economy, and thus the equity markets.

Based on the market action from recent weeks, that does not seem possible.  Action about Quantitative Easing III continuing will be needed, more than likely



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