Who the Federal Reserve Is Really Hurting

The Federal Reserve has made it very clear that it wants to stop quantitative easing. But it has also made it just as clear that it won’t begin to taper its quantitative easing program until certain conditions are met.

While speaking in front of the Committee on Financial Service, here’s what the chairman of the Federal Reserve, Ben Bernanke, said about ending quantitative easing: “I emphasize that, because our asset purchases depend on economic and financial developments, they are by no means on a preset course. On the one hand, if economic conditions were to improve faster than expected, and inflation appeared to be rising decisively back toward our objective, the pace of asset purchases could be reduced somewhat more quickly. On the other hand, if the outlook for employment were to become relatively less favorable, if inflation did not appear to be moving back toward 2 percent, or if financial conditions—which have tightened recently—were judged to be insufficiently accommodative to allow us to attain our mandated objectives, the current pace of purchases could be maintained for longer.” (Source: Board of Governors of the Federal Reserve System, July 17, 2013.)

But no matter when quantitative easing ends, one thing has become certain—it will have its victims. And the biggest victim of quantitative easing I see will be the bond market.

In its meeting in May, the Federal Reserve hinted that the quantitative easing will be slowing sometime later this year and ending completely next year. Since then, the bond market has seen selling. I have mentioned in these pages how the bond prices have declined and yields have soared higher.

The Investment Company Institute (ICI) reports that for the week ended July 2, 2013, the outflow from bonds mutual funds was $5.9 billion. (Source: Investment Company Council, July 10, 2013.)

And from the week ended June 5 until the week ended July 2, $66.65 billion was pulled from the bond mutual funds. If the bond mutual funds register a net outflow for June, then this would be the first net outflow since August of 2011.

What you need to realize is that the bond market is very big in size—much bigger than the stock market—and, if it declines, it could have a significant impact on the economy.

Consider this: if the bond market starts to see higher yields, then the mortgage rates will increase. We are already starting to see this. Just look at the chart below. It shows that companies that borrow to run their daily expenses will be paying more and in general, the cost of goods can increase.

30-Year Conventional Mortgage Rate (MORTS)

Quantitative easing in the U.S. economy hasn’t done much for the economy, and it’s just a matter of time until things turn sour.

What we saw in the bond market since May is just a minor episode of what might happen when the Federal Reserve starts to taper its quantitative easing program.

To all bond investors: be careful—to enter the bond market now would be to tread in dangerous waters.