Fed's Bold Move Ignites the Dow

Wow. What a difference a day makes.

Yesterday, analysts and commentators were busily debating whether Apple had actually surprised anyone on the planet earth with the release of the iPhone 5. While I'm sure this won't sit well with some of you, to all but the most devoted Apple fanatics, the new device amounts to nothing more than a bigger, faster, and lighter version of the iPhone 4. In response, the Dow Jones Industrial Average (INDEX: ^DJI  ) predictably climbed a meager 12 points, hardly enough to even register.

Today, in comparison, thanks to the Federal Reserve, the Dow is up a staggering 210 points. While analysts and commentators had expected the central bank to announce an additional round of quantitative easing, few expected it to move so boldly. To steal a headline from Yahoo! Finance, Bernanke truly went all in.

Fed unleashes unlimited stimulus package
In what amounts to a third round of quantitative easing, or QE3, the Fed will purchase $40 billion a month of federally insured mortgage-backed securities. According to the official announcement:

To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee agreed today to increase policy accommodation by purchasing additional agency mortgage-backed securities at a pace of $40 billion per month.

Notably, the program will be on top of the ongoing Operation Twist, under which the central bank is selling short-term securities, and buying an equal amount of long-term ones. Yet, even though both are structured to reduce long-term interest rates and, thus, spur the economy, the two programs are very different.

In the first case, Operation Twist is focused on Treasury securities -- i.e., federal debt. QE3, on the other hand, will consist of purchases of mortgage-backed securities. As a result, while the former is structured to bring down all long-term interest rates, the latter is focused specifically on mortgage rates. The belief is that lower mortgage rates will spur refinancings, which will put more money into consumers' pockets.

The second difference is that Operation Twist is balance sheet neutral, meaning that the overall size of the Fed's balance sheet won't change, only the average maturity of its holdings. Alternatively, QE3 is anything but neutral, as there are no security sales to offset the purchases. Consequently, depending on how long the latter program continues, the Fed's balance sheet could theoretically grow quite considerably.

Beyond this move, the Fed also confirmed its intention to keeping interest rates low for an extended time period, saying that "exceptionally low levels for the federal funds rate are likely to be warranted at least through mid-2015."

What does this mean for stocks?
As we witnessed today, easy monetary policy has a tendency to drive up equity prices. Not surprisingly, in turn, all 30 stocks on the Dow are in the green.

Leading the way up are JPMorgan Chase (NYSE: JPM  ) and Bank of America (NYSE: BAC  ) , the nation's two largest lenders by assets, up 4.8% and 3.7%, respectively. While lower mortgage rates will compress these institutions' pivotal net interest margins, they could also improve the quality of their loan books, as the resulting decrease in monthly mortgage payments will ease the burden on homeowners.

Also up considerably, and for the same reason, is the home improvement giant Home Depot (NYSE: HD  ) , which is currently trading 2.2% higher.

On the other end of the spectrum, though still in the green for the day, are technology companies, like Intel (Nasdaq: INTC  ) and Microsoft, both of which are likely still feeling the aftereffects of the chipmaker's downbeat earnings forecast issued last week.

The bottom line
Going forward, of course, it's hard to predict whether or not these gains are sustainable. And it's for this reason that our analysts have identified a handful of strong, well-diversified companies that pay a respectable dividend in our newest free report about three Dow companies every dividend investor needs. Simply click here to download your free copy of this report before it's too late.

Fool contributor John Maxfield owns shares of Bank of America. The Motley Fool owns shares of Bank of America, Intel, and JPMorgan Chase. Motley Fool newsletter services have recommended buying shares of The Home Depot and Intel. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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