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Fed’s ‘Sterilized’ Strategy: What It Means for Investors

Federal Reserve officials are reportedly mulling a new strategy aimed at spurring economic growth — a plan experts say could leave investors with mixed results.

The new approach, dubbed “sterilized” bond buying, involves the Fed printing new money to purchase long-term mortgage or Treasury bonds, while at the same time borrowing cash from banks and other financial institutions for short time periods, according to a report today in the Wall Street Journal.  The goal, say experts: Keep long-term interest rates low, while also squashing inflation fears that naturally pop up when the government prints more dollars.

Experts say the program could be a boon to investors in long-term bonds. By snapping up more long-term bonds for its portfolio, the Fed would drive down yields on other bonds prices off Treasurys, such as corporate bonds. But that would also push up those bonds’ prices, giving investors in those markets a boost, says Jonathan Hill, investment strategist with Gibraltar Private Bank & Trust in Coral Gables.

Those lower bond yields could also help extend the stock market’s three-month rally, say some experts, by pulling yield-hungry investors off the sidelines and into dividend stocks and other shares.

On the other hand, the move could push up short-term rates earlier than the Fed expects. The Fed would essentially be giving banks short-term bonds in exchange for cash. By increasing the supply of short-term bonds, that could cause bond prices to drop and short-term yields to increase, says Anthony Valeri, fixed income strategist for LPL Financial. Such a rise could give short-term investors a little extra yield, says Valeri, but it could also counter with the Fed’s goal of encouraging people into riskier assets like stocks.

Of course, industry observers point out that it’s unclear what action, if any, the Fed will take. Experts aren’t expecting any action to be announced after next week’s Fed meeting. They point out that the Fed has other tools at its disposal to try to jump-start the economy and stave off inflation, such as conventional bond buying and or another round of Operation Twist, the strategy it implemented last fall which involved swapping the long-term bonds in its portfolio with short term ones.

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    • As long as we all keep our eyes closed and wish really really really hard this new policy will not be inflationary. . .

    • Sterilization is an appropriate term. A little more time to enjoy life until the fun and games come to an abrupt end.

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