Monday, November 15, 2010

Bye-bye QE2?

This chart of the yield on 10-yr Treasuries shows the rather dramatic rise in rates that has occurred in the past week. As I mentioned a few days ago ("Return of the bond market vigilantes") the market is not only protesting the Fed's decision to move ahead with QE2, but now appears to be thinking that it might be cancelled or significantly cut back. This coincides with mounting opposition from all quarters to the idea of QE2, culiminating in today's release of an open letter to Bernanke from a group of notable economists and investors.

As I've said before, QE2 is not only unnecessary but foolish. The sooner it is put out of its misery the better. And to the extent that calling off further QE2 disappoints the market, that is a great buying opportunity for investors who understand that too much money is not a good thing.

UPDATE: Here is a chart that compares the 10-30 Treasury spread with the market's forward-looking inflation expectations. The action in both is fully consistent with the market changing its expectations about QE2. Less QE2 means the 10-30 spread needs to return to more normal levels, and inflation expectations have to decline.


Bill said...

How do you know that the yields aren't rising because the market anticipates the economy will get better because of QE2? I thought you've said before that rising yields are a sign the economy is getting better.

Public Library said...

TBT has been a perfect hedge if you do not fear deflation. If growth improves or Bernanke keeps the pedal to the medal, long bonds sell-off.

It might go parabolic if both occur simultaneously and for a long enough time period!

Benjamin Cole said...

Alan Blinder has a good op-ed in today's WSJ about this topic.
And yes, I hope we do have more inflation and higher interest rates. We are sinking into deflation.

Who would say QE1 did not work?

Scott Grannis said...

Bill: I do think that rising yields are a sign that the economy is getting better. A healthier economy reduces the need for QE2 and thus supports the argument against QE2. Less QE2 contributes to higher yields. It's all part of the same story.

And to Public's comment, yields could go parabolic at some point, if for no other reason than the negative convexity of mortgages.

Scott Grannis said...

Blinder's article in today's WSJ does not convince me of anything. He has always believed in government's ability to micro-manage the economy. I've always believed this ability is vastly over-rated. Except, of course, when what the government does ends up creating better incentives for private sector investment and job creation.

John said...


It appears that Bernanke has finally cracked the deflation psychology. For many TBT is not a hedge. It is a long term position.

Retail investors have been piling into bond funds to escape the volatility of the equity markets. Well, looks like the jig's up. Where's the money going to go? Much of it will find its way into.....equities. But only after the market moves higher and bond prices lower. Also, real estate will eventually recieve its share. There are lots of good properties available at reasonable prices. Buyers just need confidence another leg down is not happening.


IMO Bernanke fully intends to implement QE2, and it will probably be front loaded. It may be a mistake as you say but I don't think that is the way 'they' see it. Bring on the budget cuts!!

brodero said...

QE2 is not going to bring inflation ( wages,housing) may be not necessary
but the error would not be catastrophic...I believe the rise in yields is recognition the economy might getting a second wind.
If we get string of positive payroll numbers the foot on the gas
pedal will be lessened....

John said...

Some additional anecdotal evidence for those interested.

I just returned from a tennis tournament on Kiawah Island SC (near Charleston). An owner on the island said a local agent told him that in the past week they had the highest number of closings in many months and that activity is beginning to pick up. It could be agent BS but a good friend (and tennis opponent!) is an agent from Myrtle Beach, SC and he told me essentially the same thing. High end ($1 million & up) is still slow but $300M to $600M is active.

Similar info from a tennis friend and agent in the Baton Rouge, La. area. Lower to mid range action is steady. High end slow.

Benjamin Cole said...

What has happened to my fellow business people? You seem happy now if a few straws in the wind speak of a flimsy recover.

I want to hear somebody again say, "Man, this place is booming, booming, it Fat City, it is raining money, I am drowning in equity, I am turning away business."

You guys seem to actually want a weak economy. Are you bondholders? What is up with you?

Steve Fulton said...

Good Lord almighty--what has Alan Blinder been smoking. I know they didn't legalize marijuana in Princeton, NJ. To paraphrase, "Alan, I don't know you, I don't know Ben Bernanke, I don't know Milton Friedman--but I do know neither you or Ben is any Milton Friedman."
It is absolutely possible that the Feds trip down the monetary rabbit hole will not result in a 70's style inflation, just as it is absolutely possible that I can walk blindfolded down a busy freeway and not get hurt but if anyone actually believes you can set the rate at which a nine trillion dollar market will trade by printing 600 Billion in reserves and buying treasuries with it then I must point out that there are only 2 possibilities. You must either be incredibly naive (note I did not say stupid) or insane. I actually think there is a reasonable possibility that Ben is not in full possession of all of his faculties. The quicker that we consign this, at best useless and more likely, destructive QE2 foolishness to the ash heap, the greater the chance that the economy can get back to trying to get out from under it's other problems (which it seems to be doing as I write).

brodero said...

Gallup set a new high for the
US workforce yesterday....