I know the conventional wisdom is that Quantitative Easing programs cause rates to fall, but I am perplexed at how many times we are going to have to see the exact opposite thing happen before this myth is finally debunked. Many of you are probably shaking your head and thinking that I don’t have a clue about what I am talking about. That very well might be true, but let’s have a look at the chart anyway.
During all three major Quantitative Easing programs the US 10 year Treasury yield rose from start to finish. And each time the program ended, the rate plummeted even further as the Fed wound down its stimulus.
Over the last 5 years, the only time rates have actually risen is when the Fed was aggressively accelerating their balance sheet expansion. The moment the market realized that the Fed was slowing down their purchases, rates actually fell (bonds went up in price).
Many market pundits refuse to believe this. I can’t tell you the number of times I read about why bonds are rising because of QE. Nothing could be further from the truth. If you think about what drives bond investors, it becomes clear that the Fed expanding their balance sheet is far from bond friendly. What is a bond investor’s worst fear? In the case of a sovereign that can print its own currency and therefore default is not a concern, the greatest worry is inflation. When the Fed buys bonds and expands its balance sheet, what are they trying to create? Inflation. If the Fed bond purchases are designed to create the very thing that will cause the bond price to fall, why do market pundits continue to believe that the Fed’s purchases will cause bond prices to rise?
It is obviously much more complicated than this simple explanation, but at its root, until the economy reaches a self reinforcing escape velocity, rates will fall when the Fed withdraws their buying, and rates will rise when they resume.
The real question is when the economy will reach that escape velocity. Ever since the 2008 credit crisis as the Fed has withdrawn their balance sheet expansion, they have been hopeful that the economy could stand on its own two feet. Each time the economy has quickly stumbled. Will this time be different? I don’t know. But I do know that if we get QE4, it won’t be a time to buy bonds, but instead it will be an opportunity to short them with both fists. The prevailing wisdom will be that if the Fed is buying them, they have to go higher. But the first three times the exact opposite thing happened, so why will it be different the fourth?
S&P 500 bouncing off the 100 day moving average again…
After a shaky start to the new year, we got a big bounce in US equities yesterday that has followed through this morning. The rally has been further fuelled by last night’s comments from Chicago Federal Reserve President Evans:
*FED’S EVANS SAYS RAISING RATES WOULD BE A CATASTROPHE
*EVANS SAYS OIL IMPACT ON INFLATION TO REQUIRE CLOSE MONITORING
*EVANS SAYS WAGE GROWTH CONSISTENT WITH GOAL WOULD BE 3.5%-4%
*EVANS: DROP IN LONG-TERM INTEREST RATES `EXTRAORDINARY’ PAST YR
*EVANS SAYS HOUSING HASN’T SHOWN STRENGTH HE’D LIKE TO SEE
I have long held the belief that the Fed will be loathe to raise rates, and this seems to be the first signs of them blinking. They are only going to raise rates when it becomes brutally obvious that the time to do so was months ago.
What is interesting is that these comments have once again saved the S&P 500 from drifting below its 100 day moving average.
Apart from the September swoon, the S&P 500 has managed to only spend a few days below this technical line before bouncing. I am not suggesting you should run out and buy stocks, but if you are looking for a spot to get short, you might want to wait and see how much we bounce before giving it to them.
German bunds – “just get me in” panic
Yesterday saw some crazy action in the long end of the German bund market. At the beginning of the week the 30 year was yielding 1.34%. On Tuesday the yield dove straight down to finish at 1.17%. Yesterday the panic continued with a sickening swoosh down to 1.08%.
But by the end of the day, the yield had pushed back up to 1.24%. This has the feeling of a capitulation trade.
During the buying panic it was difficult to see where it might stop. However now that we have gotten the big reversal, I think it is time for a punt on the short side of the bund market (betting on higher yields). Don’t forget that I think that QE programs are inflationary, and cause yields to rise. As an ECB QE program becomes more certain, I believe it will cause long bunds to fall in price, not rise. I have shorted bunds and will use yesterday’s panic highs as a stop.
Quick note on the precious metals
I am running out of time, but I wanted to make a quick note on gold. Even though the US dollar keeps pushing to new highs, the gold market is quietly heading higher. This was a hated asset for all of 2014, but it looks like it can’t go down on bad news anymore. One of these days the US dollar rally will take a breather, and gold very well might explode higher. I am long all sorts of precious metals, and the more they go up without anyone talking about them, the more bullish I get…