Here is an updated review of Treasury yields since the Fed’s November 3rd press release announcing the strategy popularly known as QE2. First a recap of the Fed’s statement:
To promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to expand its holdings of securities. The Committee will maintain its existing policy of reinvesting principal payments from its securities holdings. In addition, the Committee intends to purchase a further $600 billion of longer-term Treasury securities by the end of the second quarter of 2011, a pace of about $75 billion per month.
Because the press release was published at 2:15 EST on the 3rd, I’ve set the review start date for the following day. The first chart overlays two yield-curve snapshots: November 4th and the most recent market day.
The curve has steepened, with disproportionately greater yield increases in the middle of the curve. If the Fed’s intention is to keep yields low, then the first few weeks of QE2 are not off to a good start.
The next chart shows some key Treasury yields since the beginning of the year along with the latest overnight averages on 30-year fixed rate mortgages from Bankrate.com. The general assumption is that lower mortgage rates are critical for a recovery in residential real estate.
It’s still too soon to draw any firm conclusions about the effectiveness of the new round of Fed Treasury purchases. Part of the problem is the potential conflict between promoting economic recovery and tweaking core inflation. Consider:
- If the strategy is to increase the spread, then the early results are positive, especially for the middle maturities.
- If the strategy is to reduce rates across the board to stimulate the economy, the early results are disturbing.
QE2 is a gambit. At face value, we must assume that speeding the recovery and increasing core inflation to the target rate are the true motives. The Fed says as much, and the concern of the sole dissenter, Thomas Hoenig about long-term inflation risks, reinforces this view. On the other hand, blog commentators have speculated on a range of ulterior prime motives — ranging from bank bailouts to funding Uncle Sam with interest-free loans, etc.
We are in the early days of an innovative Fed program initially planned to extend through Q2 of 2011, but with regular reviews and adjustments. Much could change, not least of which is the behaviour of foreign purchasers of Treasuries: significant cuts in future purchases would be a game-changer.
Treasury yields and mortgage rates will merit close attention for the foreseeable future.
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