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Bond and Stock Market Volatility Is Collapsing Post-QE3

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If history is any guide, investors getting long that trade are flirting with disaster.

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MINYANVILLE ORIGINAL Last week's stock market response to the QE announced the previous Thursday was rather muted as gains were consolidated with the S&P 500 (INDEXSP:.INX) closing down a mere five handles on the week. The Treasury market recovered from extremely oversold levels, but it was the mortgage market targeted by QE III that garnered the most attention and activity.

In this weekend's Wall Street Journal Weekend Investor section, Joe Light picks up on this price action and writes about investing in MBS mutual funds to take advantage of the Fed's QE III program.

The Fed said it would buy mortgage-backed securities, or MBS, for an indefinite period to bolster the economy. That could spell an opportunity for investors-and might warrant stocking up on funds that hold the securities, say analysts.

"At the very least, you want to overweight that sector," says David Ader of CRT Capital Group in Stamford, Conn. "That's the sector where you know you have a buyer of 100% of everything coming out for an indefinite period of time."

There is not an interest rate strategist on the street I respect more than David Ader, but here's the problem: Unlike most retail investors who are reading that article, Ader's clients are already overweight mortgages. The move has already taken place. From Bloomberg on Friday:

Mortgage-Bond Spreads Cap Biggest Weekly Drop Since December '08

A measure of relative yields on mortgage securities that guide US home-loan rates capped its biggest weekly drop in almost four years on speculation that the Federal Reserve will find a shortage of the bonds as it expands purchases.

A Bloomberg index of yields on Fannie Mae-guaranteed mortgage bonds trading closest to face value fell about 7 basis points, or 0.07 percentage point, today to a record low 61 basis points higher than an average of five- and 10-year Treasury rates as of 5 p.m. in New York.

This week's drop of 34 basis points, the largest since December 2008, exceeds the decline of 19 in the final two days of last week after the Fed's Sept. 13 announcement that it would expand its balance sheet with monthly purchases of $40 billion of government-backed housing debt until the economic recovery strengthens.

No positions in stocks mentioned.
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