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Central Bank Easing: Zero Hour Has Arrived


We've reached the point where monetary easing no longer has an effect on the economy.

With QE3 likely happening next week, I wanted to look back at Treasury yields during the past three easing measures.

In the chart below, note how at every point of easing, yields have been at or near their lows. Recently, 10-year Treasury yields have been stuck in a close range from 2.00% to 2.10%, despite the S&P staging a huge rally. This may be the market at work telegraphing that the Fed will ease next Tuesday, or the market asking the Fed for more easing, but it's probably a mix of both.

Click to enlarge

Either way, "Zero Hour" -- or the point at which central bank easing has no real effect on the economy -- has arrived.

Sure, 30-year mortgage rates are at all time lows, but people aren't buying new houses, they're renting. I don't see how the merits of keeping mortgage rates low and the proposed "enabling" of investors to take money out of Treasuries translates to consumers spending or saving their extra capital. Look at what happened when corporations are given tax holidays to bring back their money from overseas. That money wasn't used to create jobs, it was used to bolster balance sheets (amongst other things like cash dividends and M&A's). Same can be said for stimulus checks; where did they overwhelmingly go? Savings.

Click to enlarge

This recent statistic showed that last year $4 of debt was needed to create $1 of GDP. Compare this to 25 years ago when it took only $1 to do the same. Zero Hour is here, and has likely been for some time.

Conspiracy theorists will argue that Fed Chairman Ben Bernanke is using the equity markets as his own pet experiment. I would argue the opposite. The sole important mandate of the Federal Reserve is to preserve the banking system, and regardless of any other facts, this has been achieved. If the Fed had not acted in 2008 and last week by easing liquidity, the banking system would have imploded overnight. If one of the larger banks in the financial system would fail, the resulting daisy chain of offsetting hedges would destroy the financial system as we know it (despite MF Global's (MFGLQ.PK) failure). The total notional credit derivatives held by the 25 largest US banks alone are five times larger than the GDP of the entire world, a scary statistic that suggests that banks will not be allowed to fail.

As Todd Harrison pointed out last week, over the last year there's been a lot thrown at the market, and we're flat for the year. The same can be said for Treasuries. Despite all of the manipulation, easing, injections and interventions, yields remain at lows, and have a negative real return of 1.50% in 10-year Treasuries. If and when the Fed announces QE3 next week, it will be an effort to drive longer-maturity rates higher. However, I don't believe that shorter-end Treasury's yields will rise. It's beneficial to the rest of the world for the US to have low funding costs so that the reverse repos can continue, and so central banks (especially foreign ones) will continue their policy of buying short dated Treasury paper.

Click to enlarge

Twitter: @MichaelSedacca

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