Goodbye QE2, We Hardly Liked Ye

By: Michael Ashton | Fri, Jul 1, 2011
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QE2 is now over. Long live QE2! The following table illustrates the effect of the second bout of quantitative easing from start to finish. I've chosen two potential start dates - the actual start date of November 12th last year, and the date we knew we were going to get QE2: August 27th, when Bernanke more or less said it would happen when he discussed "Policy Options for Further Easing" in his speech at Jackson Hole.

 

   Aug 27, 2010 Nov 12, 2010 Jun 30, 2010 Net (Aug-Jun)
2yr Treasury Note 0.55%  0.51%  0.46%  -9bps 
10yr Treasury Note 2.65%  2.79%  3.16%  +51bps 
10yr TIPS 1.02%  0.66%  0.70%  -32bps 
10yr Inflation Swaps 2.10%  2.51%  2.81%  +71bps 
Grains (DJ UBS) 100.2992  115.8296  117.3552  +17.0% 
Livestock (DJ UBS) 73.7738  70.6753  72.3312  -2.0% 
Softs (DJ UBS) 127.0117  170.2196  197.7473  +55.7% 
Gold $1236.00  $1365.50  $1502.80  +21.6% 
Ind. Metals (DJUBS) 329.6994  375.1198  392.2899  +19.0% 
Crude (WTI) $75.17  $84.88  $95.42  +26.9% 
Retail Unleaded Gas $2.682  $2.886  $3.541  +32.0% 
Dollar Index 82.918  78.082  74.404  -10.3% 
Stocks 1064.59  1199.21  1320.64  +24.1% 
M2 $8,650.5 bln  $8,767.9 bln  $9,067.4 bln  +4.8% 

 

So let's analyze the effect of the Fed's purchase of $600bln in Treasuries (plus reinvested coupons and principal payments) over seven months and change. If the Fed's intention was to lower the 2-year note yield, then mission accomplished: 60% of a trillion will apparently buy you 9bps (only 5bps if we just count from November). If instead it was trying to lower longer-term rates, which was supposedly the more important goal, it failed utterly. 10y yields are half a percent higher. Now, the Fed did succeed in decreasing the real cost of debt; TIPS yields fell 32bps (although all of that happened in the Aug-Nov period) while expected inflation increased steadily.

The farmers like Bernanke, of course: Grain prices are up 17% since August, even after today's 4.4% drop in Corn and 8.9% shellacking of Wheat. Ranchers, not so much, as livestock prices are flat, but softs (coffee, sugar, cocoa, cotton) are up a whopping 56%. Of course, the rest of us are consumers and have to buy this stuff. If we want to be very uncharitable, we should also point out that the skyrocketing cost of grains helped trigger unrest in a number of countries around the world. Bernanke will get no gifts from Mubarak!

Of course gold and industrial metals are up, around 20% each although you wouldn't know it from how precious metals advocates have been whining. Crude is +27%; I'm sorry if you have to buy gasoline since retail prices at the pump are up 32%.

The dollar is worth 10% less on world markets. On the other hand, stocks are up 24%!

So if the Fed was trying to pump up stocks or nudge 2y note yields, they did a fine job. Beyond that, what we can see is...and what I've been saying all along...if you increase the quantity of money, the main thing you increase is the price level. The only reason you might expect a growth effect is if there is money illusion, meaning people see more money in their pockets and perceive themselves as wealthier because they don't realize that the dollars are worth less. That is certainly somewhat true, but the figures above suggest that the most pronounced effects were on inflation expectations and the prices of raw commodities.

Well, we shouldn't forget about this little effect as well: QE2 also kept Tim Geithner in his job for far longer than was good for the country. Obviously, Geithner knows that his job was made easier by the fact that the Fed was buying 85% of the Treasury issuance since November, and virtually 100% of the net TIPS issuance: he has apparently decided to "weigh" moving on from Treasury as soon as the budget deal is done. I'm sure the timing is completely coincidental and has nothing to do with the fact that the next guy is going to have to find a new $600bln buyer to take the Fed's place (and maybe a bigger buyer, if the Fed ever decides to sell). "Not it!"

To be fair, Initial Claims did decline from 468k in August to 441k in November to 428k last week, and to be even more fair I should point out that monetary policy typically works with a lag. Not, apparently, on inflation expectations, but perhaps we should wait a while before judging the efficacy of turning on the money gusher.

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In other news, Greece voted a second time to affirm the austerity measures, prompting much relief (again). It led to such comments as that by Belgian Finance Minister Didier Reynders, who said today "I expect we will be able to organize the payment of the next tranche of €12 billion." Hang on, "expect"? Boy, if the EU doesn't approve the payout after Greece's politicians did everything asked of them...one hopes that the statement merely didn't translate well.

Equities rallied, a semi-predictable result of quarter-end monkey business but I was delighted because implied volatilities dropped sharply as well. Out-of-the-money puts on stocks are much cheaper than they were just a few days ago, and I bought some late in the day.

Bonds dropped again, with 10y yields all the way up to 3.16%. Commodity indices declined, but a significant part of that decline was due to the shellacking that grains took today (on crop estimates that were revised sharply higher). Energy quotes were higher.

The Fed announced that it is suspending sales of the AIG and Maiden Lane securities after discovering - wait for it - that their unloading ten billion dollars' worth of various sorts of bonds was actually pushing the credit market lower. Wow, really? You don't say? Selling billions and billions will move a market? Who knew? Certainly not the people at the Fed, who declined an all-or-none bid from AIG back in March, and who continue to speak earnestly about how they will dump over a trillion dollars' worth of Treasuries when it is time to do so, and no one the wiser. Seriously, can someone put a grown-up in charge over there?

The asset markets are, I suspect, about to get sloppy. I'm really not looking forward to the third quarter (except inasmuch as I own puts). This could begin as early as tomorrow, but I suspect it will take a few days. Still, if I'd bought a bunch of stocks for window-dressing on Thursday and faced a three-day weekend with the U.S. debt ceiling still not resolved (although Congress has canceled the holiday break to work on it. Gee, I feel lots better now) and Euro politicians still so busy back-slapping each other that anything might happen. The only major data out tomorrow is from the ISM (Consensus: 52.0 from 53.5), although auto sales will come out as well. It's a holiday-shortened session in the bond market, and a three-day weekend.

That means I will not be writing a comment tomorrow, although I will be Tweeting if anything interesting happens. You can follow me @inflation_guy. Happy Independence Day, fellow Americans. Happy day-off-from-the-stinking-Americans, rest of the world!

 


 

Michael Ashton

Author: Michael Ashton

Michael Ashton, CFA
E-Piphany

Michael Ashton

Michael Ashton is Managing Principal at Enduring Investments LLC, a specialty consulting and investment management boutique that offers focused inflation-market expertise. He may be contacted through that site. He is on Twitter at @inflation_guy

Prior to founding Enduring Investments, Mr. Ashton worked as a trader, strategist, and salesman during a 20-year Wall Street career that included tours of duty at Deutsche Bank, Bankers Trust, Barclays Capital, and J.P. Morgan.

Since 2003 he has played an integral role in developing the U.S. inflation derivatives markets and is widely viewed as a premier subject matter expert on inflation products and inflation trading. While at Barclays, he traded the first interbank U.S. CPI swaps. He was primarily responsible for the creation of the CPI Futures contract that the Chicago Mercantile Exchange listed in February 2004 and was the lead market maker for that contract. Mr. Ashton has written extensively about the use of inflation-indexed products for hedging real exposures, including papers and book chapters on "Inflation and Commodities," "The Real-Feel Inflation Rate," "Hedging Post-Retirement Medical Liabilities," and "Liability-Driven Investment For Individuals." He frequently speaks in front of professional and retail audiences, both large and small. He runs the Inflation-Indexed Investing Association.

For many years, Mr. Ashton has written frequent market commentary, sometimes for client distribution and more recently for wider public dissemination. Mr. Ashton received a Bachelor of Arts degree in Economics from Trinity University in 1990 and was awarded his CFA charter in 2001.

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