It happened again... just as themarket expected it would.
On Sept. 13, the Federal Reserve announced a new plan for
quantitative easing (QE3). The plan -- which started on Sept. 14 --
is forthe Fed to buy $40 billion of mortgage-backed securities each
month until it sees a substantial improvement in the labor
The idea here is simple. By buying up mortgage-back securities
and other financial assets, the Fed is hoping to keep interest
rates low in order to spur additional borrowing, with the hope of
stimulating economic activity.
The problem is, every time the Fed embarks on another round of
quantitative easing, it's injecting billions of dollars of
additional cash into the money supply. And as any
first-yeareconomics student would know, if the money supply starts
to outstrip the supply of goods and services, prices can rise.
It's no wonder then that as soon as the market made the
announcement,inflation hawks started pounding the table.
But don't be fooled by the headlines. While the argument makes
sense in theory, it could be a while before we see any real
inflation threats start to emerge. Let me explain...
In order for there to be inflation, two things need to happen.
One, money needs to be cheap. And two, there needs to be a strong
demand for goods and services. When money is cheap and demand for
goods and services are high, it can create an environment where too
much money is chasing too few goods. The only natural remedy is for
prices to increase.
With the 10-year treasury currently yielding 1.6% money
certainly qualifies as cheap. But it's the latter part of the
equation -- high demand for goods and services -- that looks
suspect right now.
All across the world, demand for goods and services appears to
be slowing. Although central banks the world over are trying to
stimulate their economies, governments are frantically slashing
their budgets, which weighs on economic growth.
In Europe, unemployment current sits at 11.3%, the highest it's
been since its formation. Even Germany -- considered better off
than its euro peers -- has seen its unemployment rise in each of
the past six months. You can't blame them if they don't feel like
spending or borrowing, even at rock-bottom interest
In Japan, the situation looks even worse. During the past
several years, Japan has been furiously pumping money into
itseconomy ... but to no avail. In fact, in July, Japan's core
consumer prices dropped 0.3% -- the third straight month
And then there's the United States. While the economy is
undoubtedly plugging along, we are not exactly breaking any growth
records. The latest data estimates that U.S. economy grew at a
lackluster 1.3% in the second-quarter.
To top it off, the United States is also about to embark on a
program of fiscal austerity. Whether the federal budget gets cut in
an orderly fashion or via across-the-board budget cuts -- triggered
by a failure to meet the conditions of the 2011 Budget Control Act
-- is yet to be known. But cuts are coming.
Don't get me wrong, inflation is certainly something to fear. In
periods of rising inflation, there are few winners. For income
investors, inflation can be especially devastating as existing
fixed income assets take it on the chin when new fixed income
assets get issued at higher interest rates.
Action to Take -->
But right now we're lacking the demand to really bake the inflation
cake. It looks like fiscal austerity and economic uncertainty seem
to be keeping it in check. As a result, it looks like
yourfixed-income investments are safe... at least for the time
-- Amy Calistri
P.S. -- If you haven't done so, you can learn more about my
income investing advisory, The Daily Paycheck. In the past year,
I've collected more than $13,000 in dividends. Learn more about how
you can do the same thing by visiting this link.
Amy Calistri does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC does not
hold positions in any securities mentioned in this article.