David Rosenberg agrees with the prediction we made this morning, that interest rates will go down — not up (as Bill Gross thinks) — when QEII ends this summer.
His reasoning is the same as our. If the end of QEII means the end of asset inflation, that means the appeal of bonds at these levels goes up.
We are now being asked this constantly and the follow-up is “who picks up the slack if the Fed stops its bond-buying program”?
The answer(s) is hardly complicated since we have a template for this in 2010. It is a very simple guidepost.
Last year, from April 23rd through to August 27th, 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. Go back a year to the Federal Open Market Committee minutes and you will see a Federal Reserve consumed with forecasts of sustainable growth and exit strategy plans. A sizeable equity correction coupled with double-dip fears were nowhere to be found.
Now over that interval …
• S&P 500 sagged from 1,217 to 1,064.
• S&P 600 small caps fell from 394 to 330.
• The best performing equity sectors were telecom services, utilities, consumer staples, and health care. In other words — the defensives. The worst performers were financials, tech, energy, and consumer discretionary.
• Baa spreads widened +56bps from 237bps to 296bps • CRB futures dropped from 279 to 267. • Oil went from $84.30 a barrel to $75.20. • The VIX index jumped from 16.6 to 24.5.
• The trade-weighted dollar index (major currencies) firmed to 76.5 from 75.5.
• Gold was the commodity that bucked the trend as it acted as a refuge at a time of intensifying economic and financial uncertainty — to $1,235 an ounce from $1,140 and even with a more stable-to-strong U.S. dollar too.
• The yield on the 10-year U.S. Treasury note plunged to 2.66% from 3.84%.
So you see, the bond market actually does better (same was true during QE1) without the Fed balance sheet expansion than with it. Why? Because the Fed’s real goal is to ignite investor risk appetite.