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NEW YORK – The Federal Reserve and U.S. stock investors face yet another critical test at the end of January when incoming Fed chairwoman Janet Yellen takes over.
Wall Street currently expects the Federal Reserve to announce at the end of the Federal Open Market Committee meeting Jan. 28-29, the last meeting for outgoing chairman Ben Bernanke, a further “tapering” of the current Quantitative Easing policy.
The expectation is that the Fed will decide to buy $65 billion a month in U.S. debt, down from the $75 billion level currently in place and the $85 billion that was the standard last year.
With the Fed expected to continue “tapering” QE by $10 billion a month until the it no longer is buying U.S. debt, the question becomes: Will the cost of inducing foreign nations and institutional investors to buy the U.S. debt the Fed is no longer buying force bond yields to rise, reflecting a perhaps irreversible general rise in interest rates across the U.S. economy?
A rise in interest rates could trigger the popping of the stock market bubble, resulting in a downward correction that would be painful for most investors. It would particularly hit fixed-income retirees that have 401(k) and IRA funds invested in the stock market, either directly or via stock market-based mutual funds.
China, the leading foreign holder of U.S. Treasury debt, reported holding a record $1.3167 trillion of U.S. Treasury debt last November, topping a previous peak of $1.3149 billion registered in July 2011.
As a result of its substantial and continuing trade surplus with the United States, China has decided to ease off accumulating foreign-exchange reserves, with possible dire consequences for the U.S. economy.
China set a record in the third-quarter 2013 as the world’s leader in foreign exchange reserves, holding a record $3.66 trillion, triple the amount of any other country and bigger than the GDP of Germany, the EU’s largest economy.
While Japan remains close behind China as the second leading foreign holder of U.S. Treasury debt, reported at $1.1864 trillion in November 2013, China’s foreign exchange reserves have soared nearly three times Japan’s.
In 1996, China’s foreign reserves totaled only about $100 billion. But it took China only a decade to surpass Japan to become the largest holder in foreign exchange reserves, in 2006, when topping $1 trillion for the first time.
At the end of 2013, China’s foreign exchange reserves rose to $3.82 billion, some 60 percent of which is estimated to be held in dollar-denominated assets, including U.S. Treasury bills.
With China’s central bank continuing to signal a desire to diversify away from holding U.S. Treasury debt at new record levels, higher bond yields may be needed to induce China and other foreign national purchasers to continue buying the increased quantity of U.S. Treasury debt that will be on international markets as the Fed continues the planned systematic reduction of QE throughout 2014.
In December, the Financial Times reported the rise of the benchmark yield of the 10-year U.S. Treasury note to above 3 percent, the highest level since July 2011, caused financial analysts worldwide to anticipate higher U.S. interest rates in 2014 as the Fed reduces QE.
WND has reported concern that higher interest rates will increase the federal government’s cost of servicing the more than $17 trillion in accumulated U.S. national debt.
With the expectation on Wall Street that interest rates soon will rise, a speech by Federal Reserve Bank of Boston President Eric Rosengren is drawing widespread attention.
Rosengren, who just finished a year’s service on the FOMC, was a vocal supporter of the Fed’s QE policy, designed to keep interest rates at or near zero. He was the sole dissenter in his last vote as a member of the FOMC in December 2013, opposing the decision recommended by outgoing Fed chairman Ben Bernanke to begin reducing its purchases of U.S. government-issued debt.
Worried that QE tapering was almost certain to give momentum to rising interest rates, Rosengren’s carefully worded speech still managed to convey his concern that ending QE too rapidly could cause an interest-rate spike. In a chain reaction, the consequent increase in interest expense could tank the economy.
For instance, if interest rates were to rise, as many economic experts anticipate, increasing yields on the three-month treasury to approximately 4 percent by 2018 and 10-year Treasuries to approximately 5.2 percent, interest payments on the federal debt would rise to $505 billion in 2018 from the current level of $255 billion.
By comparison, the still rancorous sequester only cut government expenses by some $85.3 billion in the first year.