To: sandeep who wrote (47111 ) 3/11/2013 7:57:26 PM From: Seismo 2 Recommendations Read Replies (1) | Respond to Because of the strong relationship between the size of the monetary base (per dollar of nominal GDP) and short-term interest rates, it appears likely that short-term interest rates will be suppressed by Fed policy for some time, until Fed policy normalizes or inflation accelerates. The Fed is now leveraged 55-to-1 against its own capital. With an estimated duration of about 8 years on $3 trillion of bond holdings, every 100 basis point move in long-term interest rates can be expected to alter the value of the Fed’s holdings by about $240 billion – roughly four times the amount of capital reported on the Fed’s consolidated balance sheet . future interest on the Treasury securities held by the Fed. This interest will not be paid back to the Treasury for the benefit of the public, as the Fed has historically done. Instead, the interest will be retained by the Fed. As Bernanke indicated in his Congressional testimony last week, in language that seems almost intentionally designed to confuse: “it is an asset in the sense that it embodies a future economic benefit that will be realized as a reduction of future cash outflows.” In effect, to the extent that the Fed experiences losses because it overpaid for Treasury securities that it bought from primary dealers (comprising the too-big-to-fail banks and Wall Street investment firms), the U.S. public will pay for those losses without any need for Congressional legislation . This doesn’t mean that the Fed will refrain from continued quantitative easing, but we should all understand how this policy works, and the risks and potential costs that it quietly imposes on the public. Ultimately, the normalization of the Fed’s balance sheet – outside of weak economic conditions – is likely to press long-term interest rates markedly higher . This would be particularly true in the event that inflation accelerates and forces that attempt to normalize, which we expect in the back-half of this decade. As a result, the next economic recovery will very likely be associated first with a significant steepening of the yield curve, and only later by an inversion as the Fed scrambles to tighten. But in my view, the time to expect higher interest rates is not now. The above was excerpted from Hussman's weekly commentary last week.
