Sorry!! The article you are trying to read is not available now.
Thank you very much;
you're only a step away from
downloading your reports.

The Effects of QE on Treasury Yields -- Now the Answers Start to Matter


Why neither side of the quantitative easing debate has it entirely right.

The debate about the impact on US treasury yields from the Federal Reserve's LSAP programs - often referred to as quantitative easing -is raging into its fourth year. In fact, now that the time series are getting long enough for more robust number crunching, I suspect academics are going to really start diving in and begin the writing of history.

Practitioners, however - both policy makers and those of us who have money on the line - don't have the luxury of time. We are entering a critical phase right now. Why? Household leverage has been the prime impediment to a normal functioning of monetary policy. And it is now starting to get down to a point where monetary policy will start gaining traction. Not a lot of traction, because these processes are slow, but any traction at all means the days of the dreaded liquidity trap are numbered.

So we are now going to have think harder, and in more practical terms, about the counterfactual: Where would United States Treasury (UST) rates be without the exceptional monetary stimuli the Fed hath wrought.

There are two basic camps in this debate, and from where I sit, neither side has it quite right.

One camp says the Fed's massive purchases of USTs and agency mortgages have artificially lowered rates a lot. Looking at UST yields and spreads throughout the fixed income complex gives them sticker shock. Some fixed income managers are even mad. They fear that this is inducing a misallocation of resources, incenting higher government spending than would otherwise be the case, which is hurting savers, and might constitute a new bubble. Many in this camp fear high inflation will follow. Their prediction for when the Fed stops buying? Pain - pain in markets, pain in the economy, and pain in the budget, stemming from the higher UST rates they assume will follow.

This camp comprises much of the professional fixed income asset management crowd, the majority of sell-side strategists, a fair number of economists (for example, see the recent op-ed by Marty Feldstein in the Wall Street Journal), and virtually all of the policy bears (think, for example, ZeroHedge or CNBC's Ric Santelli).

The second camp claims it is all about expectations, not physical purchases, and that QEs have actually raised UST yields relative to where they would otherwise be. Joe Wiesenthal over at Business Insider was perhaps the first to propagate this view. Others, like Matt O'Brien at The Atlantic and Matt Yglesias at Slate, have more recently laid out the same basic case: Looser monetary policy from central bank bond buying raises, rather than lowers, rates because the indirect effect through expectations on future nominal GDP growth is greater than the countervailing pressures from bond purchases.

This camp comprises an increasing number of sharp-eyed financial/economic journalists, some of the more nuanced fixed income veterans, most saltwater economists, and a lot of equity managers (who always seem to be on the lookout for a bullish story). This view is always buttressed by some version of the very convincing chart shown below, in this instance lifted from Matt O'Brien:

In it, one can see very clearly that when the physical purchases of USTs and mortgages were taking place, bond prices were indeed going down and yields were higher.

Conversely, the moves higher in price and lower in yield happened when the Fed "wasn't in the market."

The rationale is simple: The Fed tended to hint at or announce QE programs when the economy and markets appeared to be weakening sharply. The chart shows that even though we were in the throes of a deep liquidity trap, the psychological effect of Fed support was strong enough to snap us out of slide into self-reinforcing pessimism and move us away from nastier equilibria.

Okay, that was easy. So, case closed? QE means higher rates, right?
< Previous
No positions in stocks mentioned.
Featured Videos