Stock Markets Surge on Fed's $600B Plan

Nov. 4, 2010— -- Stocks surged today after Wednesday's announcement that the Federal Reserve will purchase $600 billion worth of Treasury securities to boost the stagnant economy.

The S&P 500 stock index rose 1.9 percent to its highest since the start of the financial crisis in September 2008, when Lehman Bros. collapsed. The Dow Jones Industrial Average surged 219 points or 2 percent as of its 4 p.m. close. Markets around the world rallied on hope that the Federal Reserve can somehow return jobs and investment to pre-crisis levels.

The most direct effect of the Fed's move will be on interest rates and consumers' investments.

This is the Fed's main tool for changing monetary policy. The Fed is going to print more money, thereby making money cheaper to borrow and interest rates lower.

"One could argue that interest rates are too low already and Treasury prices are too high," said James O'Sullivan, chief economist with MF Global.

Lower interest rates also could lead to lower mortgage rates for consumers looking to buy a home. Consumers who couldn't afford to borrow money or didn't want to borrow money now have greater incentives to do so at lower rates. With more people buying homes, the prices of homes could increase and lead to a boost to the housing market.

For consumers with investments in the financial markets, a large purchase like the Fed's, which will take place at a pace of about $110 billion per month until June 2011, theoretically should encourage investors to place their money in places with higher risk and returns, like the stock market, instead of low-yielding bonds, for example.

As those assets increase in value over time, that means a better stock market and potential gains in wealth for people who own stock for retirement or general purposes.

"They expect this to have a positive impact from lower interest rates and they think it will induce bankers to lend more money, but that's an unsupported premise," said Bill Bartmann of Bartmann Enterprises. "There's a lot of supply but no demand. This will not increase demand if the rate is so shockingly low already."

Fed Buys More Treasury Bills Than Expected

Prior to the announcement, economists originally expected the Fed to buy about $500 billion worth of treasuries. That amount could potentially add 2 to 3 percentage points to GDP growth in each of the next two years by the Fed's projections, according to MF Global's O'Sullivan.

"A $500 billion purchase would not have had a huge impact on growth. If needed, the Fed could scale it up," O'Sullivan said of the Fed's ability to increase its purchase size beyond the $600 billion.

But there are dangers that purchasing too much will have a greater effect on interest rates than expected.

"There's a risk that that Fed officials will boost inflation expectations more than they drive down interest rates," O'Sullivan said.

And greater inflation leads to more unstable, higher prices for commodities and consumer goods.

In addition to the risk of inflation, there could be other unanticipated effects. A decrease in the dollar, or cheaper money, is better for U.S. exporters, who can attract foreign buyers with less expensive goods. However, it's worse for travelers and companies who have less purchasing power in other countries.

Mickie Siebert, chairwoman of Muriel Siebert & Co., said only drastic results would cause the Fed to change the direction of its $600 billion purchase plan.

"They would have to have good reason, like a change in inflation or seeing employment increase," said Siebert. "The interest rates can't go much lower."

Siebert said the most important and long-lasting effect of the Fed's purchase on the economy is if more jobs are created.

"When companies can borrow such cheap money, maybe they can start hiring and will create salaries and consumers will spend some of it," said Siebert. "Consumers have been pretty conservative. They've been paying off their debt, which is good. When they do start to buy, they'll be in a better personal financial condition."

Fed Critic: 'Doing the Same Thing and Expecting Different Results'

Some analysts said the Fed's actions will do more harm than good.

"The actions today will help the S&P 500 but will have a negative impact on the dollar," said Bartmann. "So for all of us, that has negative ramifications."

Bartmann believes the Fed acted out of desperation, with few options to handle a stagnant economy and unemployment rate, which stood at 9.2 percent nationally in September. He said the Fed's purchase is similar to the $787 billion American Recovery and Reinvestment Act that the president signed in February 2009.

"This is the age-old definition of insanity," Bartmann said. "They're doing the same thing and expecting different results."

Other analysts said the Fed's actions are not enough and the new, Republican-controlled House being seated in January will need to enact additional policies.

"We can't just let the Fed Reserve do it," said Allen Sinai, chief global economist at Decision Economics. "We need Washington to boost jobs and deal with our deficit and debt problems. We also need to get our budget done. It's totally irresponsible."