We’ve been hearing much about quantitative easing recently. What exactly is quantitative easing, and more importantly what does it mean for you as an investor?
The Federal Reserve is expected to announce a second round of quantitative easing (dubbed “QE2”) at its next meeting on November 3. Quantitative easing means that the Fed, which can no longer lower interest rates –which are already close to 0% – to stimulate growth, will inject more liquidity into the economy by buying government debt and mortgage-backed securities. The notable difference between QE2 and the previous round of quantitative easing implemented earlier this year is that the Fed might also buy corporate debt this time around.
The likely impact of another round of quantitative easing is higher bond prices and lower yields. Historically, the role of fixed income instruments such as corporate bonds and the Prime Consumer Notes offered by Lending Club was to offer a dampener to overall portfolio volatility, while also providing investors with sufficient current income to either reinvest or spend. However, today’s world offers very little in terms of current income given historically low rates. Your return from many fixed income instruments, such as bond mutual funds, is now heavily dependent upon future price appreciation/depreciation, rather than current income.
Yields on most fixed income instruments were already near all-time lows and the next wave of quantitative easing will likely result in even lower yields. So, where can fixed income investors go to get yield?
In the chart below you can see a traditional fixed income yield spread analysis that highlights the BA Merrill Lynch High Yield Master Index, Lending Club Notes, and U.S Treasuries (3-5 year durations). The Treasuries are represented here as the baseline. What the data show is that spreads on high yield corporate bonds have fallen a great deal and are now back to pre-crisis levels, while the spreads on Lending Club’s notes remains very large.
Today, Lending Club has lowered rates on its personal loans in response to the overall economic environment, and in an effort to continue attracting prime and super-prime borrowers, who typically make decisions based on rates and monthly payments. Even after taking into account today’s rate reduction, the yield spread on Lending Club’s Prime Consumer Notes remains near all-time highs. Our Notes also offer a relatively unique opportunity to earn current income in today’s market.