The big issue looming over the market currently is Quantitative Easing. We have a number of very influential Fed members speaking publicly in support of more QE. The more Fed speeches I read the less I doubt that they will do it. The Fed maintains that they are data dependent...and the data continue to point toward weakness. This morning we got more data and these numbers would support those Fed members in favor of another round of QE.
The ADP Employment Change figure was expected to post a positive 20k reading…the release was actually -39k. The market is rallying strongly on this data. The 10-year Treasury is trading up ¾’s of a point to trade at 2.38%. This is what it looks like when the market begins to price in more QE. If everyone knows that the Fed will be in the market buying Treasuries over the next year then market participants will want to take positions before the Fed starts putting money to work. The market buys now while rates are high rather than waiting until after the Fed throws $500 billion to $1 trillion into the market and squashes yield levels. Yep…you read that right…I said “while rates are high”. The next FOMC meeting is on 11/3/10. It is widely anticipated that they will announce the next round of QE at that meeting.
If the Fed starts another round of QE they aren’t going to push rates down just for a month or two and just by 10 bps or so…this will be a longer term deal. Will it be a year? Two years? It’s impossible to tell how long they will keep rates low…but we know it’s not going to be a short period of time. We’re three years into this business cycle, Fed Funds is at zero percent, the Fed says it’s going to stay there for a long time, and they are about to embark on another massive round of quantitative easing. Again I think of the economist in Japan and when it was that they realized that they were in a “lost decade”?
Where will yields be after QE?
Bank of America recently changed their forecast for the 10-year Treasury based specifically on a scenario of another round of QE. Based on this expectation they’ve lowered their forecast on the 10-year Treasury…for 1Q 2011…to 2.00%.
That is a remarkable forecast. Keep in mind that at the height of the crisis…during the economy’s darkest hours…the 10-year Treasury only hit a low of 2.08%. Now B-of-A says the next round of QE will push the 10-year yield even lower than that. It’s difficult to get your head around that number…but it provides a glimpse into what the near to mid-term future could look like under a new Quantitative Easing program.
What to do?
It looks like the stars are aligning for another round of QE. If you expect this to happen, and if you anticipate having to put any money to work over the next quarter or two (or four for that matter)…you may want to consider buying bonds right now rather than waiting and doing it after the steamroller has come through. As low as investment yields look right now…they will be a whole lot lower after the next round of Treasury purchases by the Fed.
It’s really a question of “do they” or “don’t they”. If they do embark on another round of QE then rates are going lower…no doubt about it...the entire goal of QE is to drive rates into the dirt. If they don’t do the QE then we’ll likely see rates stay in the range we’ve been in over the last 6 months or so.
Given the current landscape there appears to be very little downside to accelerating your bond purchases. It sounds crazy doesn’t it? I can hear many of you shouting at the computer right now “why in the world would I load up at these levels?” The answer is because the levels we have today are going to look great after the Fed starts buying more Treasury bonds, and in six months time you’ll probably be staring at this screen asking yourself “why didn’t I buy back then?” Rather than wait until the 10-year is trading near or under 2.00% why not put that money to work now and lock in the extra yield?
At best you get in at much higher rates than will be available after the Fed starts the next round of QE. Your worst case is limited because the economy still stinks and nobody is talking about raising rates any time soon.
You have some upside to purchasing before the next round of QE, and little downside if you buy and they don’t do it. It’s essentially buying out of self-defense.
If you have any questions or if there is anything I can be doing for you just let me know.
Steve Scaramastro, SVP
800-311-0707
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