A slow recovery seems to be underway—slow enough that the Federal Reserve believes it's time for another round of quantitative easing. Under this plan, the Fed would buy up a large amount of long-term treasury bonds in hopes that another program (similar to the first one that began in 2008) would push interest rates down further and spur more lending, with the goal of jump-starting economic activity. In a speech this morning, Fed chair Ben Bernanke hinted that the Fed will announce another asset purchasing program at its next meeting in November. The question now is: How big will the program be?
In a recent post, Yahoo Finance editor Daniel Gross explains why he believes that more quantitative easing isn't an effective use of government funds. Gross says the effects would be minimal, and instead Bernanke should try to get Congress involved in helping kick-start the economy. Options include a payroll tax holiday, rebates, tax reductions, infrastructure spending, or more aid to states, Gross says. "Monetary policy alone didn't get us into this mess. And while it may be an extraordinarily powerful lever, monetary policy alone can't get us out," he writes.
[See U.S. News's Why More Quantitative Easing Could Be a Mistake.]
Bond giant Pacific Investment Management Co. (PIMCO) is already preparing for "QE2" by selling treasury bonds in its portfolios. Bloomberg reports that PIMCO believes treasuries are no longer attractive and that the bond rally could be coming to an end soon. "Even if the QE process is large and rates decline further, in our view we're approaching the end of the bond market rally," says Douglas Hodge, chief operating officer at PIMCO. "From where we sit, it's very hard to suggest there's going to be that kind of price appreciation that we've seen in bonds over the last 12 to 24 months." Instead, Hodge says PIMCO sees opportunities in developing markets such as India, China, and Brazil, in areas like infrastructure debt. PIMCO Total Return has gained 12 percent over the past year, beating almost three-quarters of its peers, according to Bloomberg.
What does all this mean for investors? Part of the reasoning behind the Fed's strategy to buy up more assets is that inflation isn't growing at a fast enough pace. But just because inflation doesn't seem like a problem now doesn't mean it won't creep up over the next few years. A recent U.S. News article tackles the issue. Although there's been plenty of buzz about the economy slowing down and prices falling, some analysts expect the Fed to raise interest rates soon to bring inflation back to a more "normal" level of about 2 to 3 percent. Whether that happens in two weeks or two years, investors should be prepared.
"Inflation is probably the biggest secret enemy of people's portfolios over time," says James Early, advisor of the Motley Fool Income Investor newsletter and a former hedge fund analyst. "It's sort of an insidious force that decays your purchasing power over the years if you have a long-term inflation." To ensure that your money is protected in an inflationary environment, investors might consider buying Treasury Inflation-Protected Securities (TIPS), commodities, or an index fund of large companies like Vanguard 500 Index that tracks the S&P 500, according to Early.
For more investing advice, see U.S. News's newly launched The Smarter Investor.