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Thanks For Following our blog.  Our goal is to post a Bi-monthly Blog providing Guidance to help you Retire Once and Retire WELL!!

We have changed our blog address several months ago, so please follow us at our new address......

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The latest blog is entitled.... "The Great Misconception"

The U.S. Economy.. Slowing or Growing??

So it's now official, the U.S. Economy is going through a “soft spot”. According to the U.S. Federal Reserve Chairman Ben S. Bernanke, speaking last week at an International Monetary Conference in Atlanta:

1. "The U.S. economy is recovering from both the worst financial crisis and the most severe housing bust since the Great Depression, and it faces additional headwinds ranging from the effects of the Japanese disaster to global pressures in commodity markets. In this context, monetary policy cannot be a panacea."
2. …the economic recovery is “uneven …and frustratingly slow
3. "The Fed will keep interest rates bottomed out for “an extended period."

A few conclusions spring forth from these quotes:

1. The Fed will keep Interest Rates low for as long as possible; longer than most economists currently believe. Bonds won‟t be under too much interest rate pressure for a while yet.
2. Chairman Ben Bernanke currently feels the launch of a third round of monetary easing will probably do nothing to stimulate "real" economic demand; principally meaning create jobs.
3. Ben is looking for help from the Government and Private Sectors in his efforts to inflate the economy.
4. The Fed expected QE2 to have more impact on jobs and GDP. The money benefited the banking industry but not industry in general.

It's possible to explain away the "soft spot" as a result of the Spring 2011 Supply Shocks in Japan and the Middle East; it may even be possible to extrapolate this thinking to justify a return to GDP growth in the Fall.

But one thing remains, until the job market shows signs of sustained improvement, long term confidence in a persistent domestic economic recovery will be questionable. 

“Until we see a sustained period of stronger job creation, we cannot consider the recovery to be truly established”, another quote from Ben Bernanke

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401k To Roll or Not to Roll ??... That is the Question

Whether or not you should Roll your 401k or retirement account into an IRA is often a question that retirees ask.

It is a good question to ask and you want to be sure that you make the right decision. If you choose to roll you must do it correctly to avoid any unnecessary tax burden. When looking at this issue the main questions to ask are…

• Do I have many more years to work and if so does my employer match my contributions
• Does it concern you that the options that you have inside of a 401k are limited
• Would you like to have the freedom to Invest ANYWHERE which could greatly reduce risk
• Does the Idea of having more control of your assets appeal to you?

These are just a few of the questions that should be asked in determining whether or not Rolling to an IRA is the right fit for you. It is always a good idea to have those questions answered by an independent professional you can trust!

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The Dollar and Commodities

Commodity prices have been moving higher and higher for some time now. This is fueling price inflation across the globe. Gold has risen to such a high that even Mr. T of the "A" Team is considering selling all his gold necklaces.

You will hear many reasons quoted for this rise including:

• Supply – as the world exits from recession, commodities will appreciate in price.
• Demand – if China keeps expanding they will consume the entire world's supply of commodities by a date that's not too far away.
• Risk – the world is in such a bad state your money is only safe in Gold at $1,500 an ounce.
• Speculation – commodities can only go up.

What we have actually seen is the U.S. Dollar often times moving in an inverse manner to that of commodities.

The View from Europe

Imagine living in Euro land last summer when one Euro bought you $1.20 when oil cost $80 a barrel. You would therefore pay 66.67 Euros (80/1.20). Fast forward to last week when oil averaged around $110 a  barrel and one Euro bought you $1.47. That meant that oil now costs 74.83 Euros (110/1.47).

For American residents, oil has jumped 37.5% from last summer, a rise which dramatically changes many business models and figures on everyone‟s “Inflation radar”. 

For those earning and spending Euros (including many of our own multinationals), oil went from 66.67 Euros to 74.83 Euros, a rise of 12%. Not an insignificant jump, but approximately one-third of the increase experienced in the U.S. If you are spending Australian Dollars, you may have seen oil go down in price!

On a Euro weighted scale, Oil has risen 12%. This is certainly not a speculative bubble; it is a more realistic reflection of the prevailing Global Demand economics associated with the continued growth of Global GDP.

Sure, Oil is not cheap as it once was in America, but remember, this is a “weak currency” issue which  isn't a big factor for those with a strong currency. Anyone who travels overseas will probably tell you how expensive everything is – “these days”.

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The Government, Banks and the Importance of the Yield Curve

What's this all about

A Yield Curve is generally a chart showing the relationship between the Interest Rate and the Time to Maturity of a Bond. It is widely used by Fixed Income investors and economists as an economic prediction tool. This week’s Thought provides background to support the theory that the end of Quantitative Easing may not be as bad as many think. Those forecasting the end of economic recovery once the Government shuts off the monetary faucets may be premature. Quantitative Easing has really been about supporting the banking system, not creating jobs and stimulating the general economy.

The Yield Curve

The current yield curve for U.S. Government Treasuries is shown below: the longer the maturity, the more yield (or interest) an investor requires as compensation for the longer holding period and the additional risk this may entail.  As an example of how this helps economists, a steeper curve as you move to the right usually signifies a higher probability of future interest rate rises.

                                     

The Treasury Yield Curve is also an indication of future interest rate policy in that it shows the ‘risk-free’ investment return available by buying a Bond which is backed by the U.S. Government.

  

Anyone buying or selling debt has to compete with this curve. For example, if the U.S. Government will pay you 3.6% a year to loan it money, why would you consider an income investment yielding any less? You wouldn’t, you would ask for a higher return to compensate you for the higher risk. 

The higher the implied risk, the larger the yield “spread” between the competing investment and the U.S. Treasury of the same maturity. Corporate Bonds, which carry the risk of corporate failure and default on interest payments, have similar shaped yield curves but feature higher interest rates. 

One important feature of the current yield curve is the “near-zero” short term level. If you loan money to the U.S. Government for between one and three months, they will pay you virtually zero interest. The interest rate only goes above 1% for loans of three years or more. Normally, short term interest rates are 2% to 3%. 

Banks and the Treasury Yield Curve 

Banks generally borrow at the short end of the yield curve and lend at the long end. Therefore, their profit margin depends on the difference or spread between long term and short term interest rates.  

For example, if a bank issues a 30-year mortgage at 6.6% (the 30-year Treasury plus 2%) and borrows the money from the Government at 1.3% over 3 years, they make a 5.3% margin in return for managing the difference in loan maturities and the difference in risk between lending money to a home owner and borrowing from the U.S. Government.

Note: Pretty much all loans are related to the Yield Curve because all lenders have to compete with the risk-free rate of return offered by the U.S. Government.

Federal Funds Rate (FFR)  

In reality, banks borrow money from other banks at the Federal Funds Rate (FFR) which is controlled, but not set, by the Federal Reserve.  The Fed influences the FFR by controlling the supply and demand for Treasuries.  Bottom Line: The Federal Reserve is lending money to banks, through Quantitative Easing, at near zero short term rates.  

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WILL INTEREST RATES BE RISING SOON?

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Reduced Demand for U.S. Treasuries

At the recent Federal Open Market Committee (FOMC) meeting, a number of members suggested they would be comfortable supporting an increase in interest rates. A few meetings ago, no one was talking about increasing rates, now we are seeing growing Fed support.  Banks are slowly starting to allocate capital to lending activities instead of using it to buy Treasuries.  Reduced buying of Treasuries will reduce demand. 

Moreover, Chairman Ben Bernanke gave a fairly clear indication that QE2 will end and will not be replaced by another round of easing. Quantitative Easing is the mechanism by which the government has kept interest rates low for so long. By buying up many of its own bonds, the government kept demand for Treasuries high which allowed prices to remain high. High prices result in low yields which lead to low interest rates. As demand falls, the Government will have to increase yields to attract more investors. Therefore, if Quantitative Easing ends, expect interest rates to start rising. 

In addition to the prospect of the U.S. Government ending purchases of their own Treasuries, Japan will probably sell some of the U.S. Treasuries it owns in order to fund disaster relief. Putting these securities on the market may reduce demand and prices further. Falling prices will mean rising yields – a.k.a. rising interest rates.

As demand for U.S. Government debt falls, the government will have to raise the yields it offers to attract buyers. This means interest rates will probably rise as bank lending rates are set, in part, by Treasury interest rates.

Federal Reserve Activity

In addition to the change in FOMC opinion discussed above, the Federal Reserve has quietly embarked on two programs which reverse the trend of pumping money INTO our economy:

•  On March 18, it announced that it would start SELLING a $142 billion portfolio of mortgage backed securities acquired in the midst of the financial crisis.
•  On March 23, the Federal Reserve announced it would start reverse-repurchase transactions.  Reverse repos are designed to take cash OUT of the banking system and raise rates.

It appears the powers that control our macro-economic policy are moving from Monetary Easing to Tightening.  This is a good sign for the economy as The Fed must feel growth is strong enough to sustain itself

without the need to pump in liquidity.

Monetary Tightening Begins?

Investors and the press tend to focus on the Federal Funds Rate as the measure of Interest Rate levels; therefore the media didn't take much notice of the Fed’s actions listed above. However, The Fed's moves were the first two definitive monetary tightening actions. We've gone from talking about reducing the money supply to actually taking physical steps – this is important.

Rising Inflation

Anyone think inflation isn’t rising? Although oil price inflation is well documented, increases in a wide variety of producer and commodity prices are now finding their way through to consumer prices.  In February 2011, U.S. consumer prices rose at their fastest pace in more than 1-1/2 years. Food prices soared 3.9 percent in February, the biggest gain since November 1974.

Rising Inflation normally leads to Interest Rate rises.

There are many temporary issues causing commodity prices to rise – Middle East unrest, Japanese supply issues, etc - and these rises could therefore prove temporary, if and when the various causes dissipate.  When companies start to raise the prices they charge the consumer it indicates growing confidence in the demand for their goods. Until now, many finished goods producers have absorbed increased costs of raw materials. It appears this may be coming to an end.  Increased confidence in consumer demand is a positive indicator for the economy and rising prices may help companies beat their revenue targets in their quarterly reports.  

Net Effect of Rising Interest Rates

If the Government allows interest rates and inflation to rise in a controlled manner, it means they feel the economy is back on the sustained growth track, despite all the headwinds and shocks to the system.  Net-Net, this is good news for many companies in the longer term. The Global Financial System still contains numerous imbalances which will take years to either unwind or for growth to catch up.  Most strong stock markets are predicated on a healthy banking system. We are seeing evidence that Banks are starting to heal their financial woes.

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Is the U.S. Stuck in a Liquidity Trap?

 NEW BLOG ADDRESS

Thanks For Following our blog.  Our goal is to post a Bi-monthly Blog providing Guidance to help you Retire Once and Retire WELL!!

We have changed our blog address several months ago, so please follow us at our new address......

http://blog.wallfinancialgroup.com/

The latest blog is entitled.... "The Great Misconception"

 What’s a liquidity trap?

A situation where all attempts to stimulate an economy fail is normally described as a Liquidity Trap. Traditionally, stimulus involves lowering interest rates and increasing money supply.  Basically, a Liquidity Trap is where a government pumps money into an economy but the people/organizations with spendable assets resist the temptation to spend/invest those assets. If the news is full of adverse events, civil unrest, natural disasters or predictions of falling demand, it’s easy to keep your money in your pocket. A more technical explanation would define a Liquidity Trap as a period where continued injections of liquidity into the economy have no effect on demand or interest rates, a.k.a. Infinite Elasticity of Money Supply.

OK, we are not here for Economics 101, so let’s move on to the important stuff…

Why is a Liquidity Trap Important?

If we are in a Liquidity Trap, the current U.S. macro-economic policy of Quantitative Easing (Q.E.) will have no further effect on real economic growth. We can continue to increase the national debt and deficit for no reason.  Think of money supply as a rubber band. As the band (money supply) is expanded by pulling on the right hand side, demand (the left hand side) should also move at some stage.  However, it remains stubbornly stationary, no matter how far money supply expands.

We call this Infinite Elasticity – the government can expand the rubber band by printing more and more money, thereby increasing its supply, with little or no net effect on the economy.  A second metaphor is Q.E. is like “pushing on a string” – push as hard as you like on one end, the other end barely moves.  Moreover, by “Easing” vast “Quantities” of money into our economy,  the Federal Reserve thought banks would finance more loans at “too good to resist” interest rates. This would help the housing market to recover and stimulate investment, consumer and capital spending.  Instead, the banks invested the money themselves, often by lending it back to the government.

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