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What Does QE2's Ending Mean to You?

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The Federal Reserve's controversial QE2 (quantitative easing, Round 2) officially ended June 30, and the market largely shrugged it off. Bond yields rose a fraction of a percent the next day, and stock prices actually rose a bit as well.

For at least the second time this year, the prophets of Armageddon were proved wrong as the end of even the financial world failed to materialize with QE2's passing. That said, QE2 did target $600 billion at the bond market, so the absence of the program will be noticed.

A plus for savers, a loss for borrowers
The biggest winners from the end of QE2 are those who are either actively saving new money or who have maturing CD or bond ladders they're planning to roll over. With less buying pressure on government bonds, interest rates that are set by, tied to, or otherwise somewhat linked to Treasury rates should rise.

If last week's relatively small moves in the bond market are any indication, there likely won't be much of a move, but when you're starting from savings rates below 1%, every little bit helps. Of course, on the flip side, debtors will be feeling the pinch a bit more, as every rise in rates means they'll face higher borrowing costs.

If there's something that both borrowers and savers can appreciate, though, it's that higher rates have the potential of staving off future inflation. With the most recent annual inflation rate back up around 3.6%, that once-dormant worry has again been rearing its ugly head. Should higher rates from the end of QE2 bring with them more stable prices, it's a good thing, as stable prices are generally seen as the best condition for promoting real economic growth.

What about investors?
In the corporate world, businesses are affected by higher rates, just as consumers and investors are. Those that make money off interest rate spreads, like mortgage real estate investment trusts Annaly Capital Management (NYSE: NLY  ) , Chimera Investment (NYSE: CIM  ) , and MFA Financial (NYSE: MFA  ) will likely be hurt by this shift, at least in the short term. Over the long run, though, the well-managed ones can adjust and make money in the new, higher-rate reality.

Likewise, homebuilders such as D.R. Horton (NYSE: DHI  ) and Toll Brothers (NYSE: TOL  ) , which depend on people's ability to borrow large sums of money, won't be helped by higher rates. After all, they can't sell homes to people who can't make the payments, and higher rates mean higher payments for anyone needing a mortgage to buy a house.

Still, if there's a bright side to higher rates, it's in companies with clean balance sheets that earn some of their keep off of "floating" other people's money. Payroll processors ADP (Nasdaq: ADP  ) and Paychex (Nasdaq: PAYX  ) fall into that camp. They hold their clients' cash between the time it gets remitted to them and the time their clients' employees cash their checks, and they collect interest during that window. Higher interest rates translate directly to higher profits for them.

Upside, downside, net wash
As with most things in life and investing, there are both upsides and downsides to the end of QE2. If you're actively saving and investing, higher rates mean more money in your pocket and a chance for higher long-term returns, albeit at the potential for short-term dislocation during the adjustment window.

If, on the other hand, you're a debtor, higher rates will raise the cost of any future borrowing or any existing borrowing with floating interest rates. If you think the end of QE2 means the start of a Federal Reserve campaign to contain inflation through higher interest rates, now may be your last, best chance to lock in low, fixed long-term rates.

At the time of publication, Fool contributor Chuck Saletta owned shares of Annaly Capital and Paychex, and his wife owned shares of MFA Financial. The Motley Fool owns shares of Chimera and Annaly Capital. Motley Fool newsletter services have recommended buying shares of ADP and Paychex. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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Chuck Saletta
TMFBigFrog

Chuck Saletta has been a regular Fool contributor since 2004. His investing style has been inspired by Benjamin Graham's Value Investing strategy. Chuck also can be found on the "Inside Value" discussion boards as a Home Fool.

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