Wednesday, October 20, 2010

Our Economy For the Past Week


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OVERVIEW ~ October 4 through October 8 ~ From its 2.528% opening level, the 10-year Treasury note edged still lower, ending at 2.382%. The Dow Jones Industrial Average (DJIA), meanwhile, climbed from 10829.68 to the 11,000 mark, ending the week at 11,006.49. Both benefited from announcements that the Federal Reserve is likely to initiate further quantitative easing in the near term. The euro, again with investors worried about the Fed’s quantitative easing that could further weaken the dollar, rose against the dollar slightly. And gold continued to climb, reaching slightly above $1350 by the end of the week. The average 30-year fixed rate for Freddie Mac, fell 5 basis points to 4.27%, and the HSH Associates computation (which includes jumbo rates) declined from 4.75% to 4.66%.

FOCUS ~ What is QE2? “QE2” stands for the second major phase of the Federal Reserve’s “Quantitative Easing.” And “quantitative easing” is a group of measures the Fed can take to keep interest rates low or make them even lower and, quite possibly, to raise the level of inflation slightly.

Having pushed the fed funds rate to a range of 0% to 0.25%, the Fed really doesn’t have this tool at its disposal; it can’t lower this rate further. So it must call upon other ways of keeping rates low.

The most-discussed option is for the Federal Reserve to buy up Treasury securities, making it certain that there will be plenty of buying pressure for the securities. That will translate into higher value for the securities, which in turn means their yields will be even lower.

There are positives and negatives with this option. It usually reduces the value of our currency, meaning the dollar’s exchange rate falls relative to the exchange rate of other currencies. As a result, for the holders of the other currencies, this can mean that their dollar-denominated investments lose a bit of value (a negative, since it decreases their yield) and that the lower value of the dollar means an effectively lower price for our exports (a benefit to the U.S. because we can sell more exports if our price declines).

Indeed, there is much discussion currently about how several nations, including the U.S., are handling their currencies, specifically trying to push their exchange values lower in order to give their own exports a pricing edge. Still, the DJIA’s levels have often risen and interest rates fallen when the Fed discusses a likely QE2.
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