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Who, Besides Ben Bernanke, Wants to Buy Bonds?

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Next week, on March 15, the Fed’s rate-setting committee meets and most market observers expect Ben Bernanke and his FOMC allies to complete their controversial $600 billion Treasury securities purchase program known as QE2 in June.

But, when that program concludes, what happens next in the capital markets?

As we detailed in an article this week, there is a lot of discussion about what the end of QE2 will mean for the stock market. After all, the goals of the extraordinary program were twofold: to drive down long term interest rates and to push up stock prices.

A lot of the pros on Wall Street are getting nervous. The most recent TrimTabs survey of hedge fund managers showed that these traders have turned bearish on US equities, with most managers attributing the stock market rally to QE2. Many think this rally will end when the quantitative easing stops in mid-year.

Specifically, about 40% of the 89 hedge fund managers surveyed are bearish on the S&P 500, up sharply from 26% in January, while only 26% are bullish, down from 37%. Bullish sentiment less bearish sentiment is negative for the first time since November.

Another concern is what the end of QE2 means for Treasuries. If Bernanke and his buddies stop buying bonds then what investors are out there who will pick up the slack?

This could spell trouble. If bond prices fall, and yields rise, that creates another hurdle for this nascent US economic recovery. The yield on the 10-year note acts as a benchmark for consumer and corporate borrowing. So, as it rises, so too does everything from mortgage rates to car loans.

At least one prominent bear, however, isn’t worried about a sell off in the Treasury market in a post-QE2 world. Gluskin Sheff’s David Rosenberg argues that, when the Fed puts an end to quantitative easing, risk appetite fades and the economy sputters, which sends investors scurrying back into the safe haven of government debt.

In fact, that’s what happened last year, between April and August, when the Fed allowed its balance sheet to shrink from $1.207 trillion to $1.057 trillion for a 12% contraction as QE1 drew to a close.

What happened in the Treasury market? The yield on the 10-year U.S. Treasury note plunged to 2.66% from 3.84% as prices rallied.

“So who buys the bonds when Ben leaves the building?” asks Rosenberg. “The same folks who were the buyers last year from April to August. The ones who were switching out of equities, commodities, and other risk-assets."
POSITION:  No positions in stocks mentioned.