QE2 is coming, and it isn’t stocks the Fed buys in large quantities with its quantitative easing. It buys treasury bonds, in an effort to drive long-term interest rates down, which should drive the price of bonds up.
But the bond market hasn’t been as excited about the idea of all that buying as the stock market has been. In fact, just the opposite. Treasury bonds have been tumbling since late August.
For instance, 30-year bonds have lost roughly 3.4% of their value in less than two months. That’s a noticeable hit to an income asset that yields roughly 3.9% a year.
The popular iShares 20-yr T’Bond etf (TLT) has fared even worse, plunging 7.2% in less than two months.
Yet investors have continued to pour money into bonds and bond funds at an unusual pace, as has been the situation all year. Strategic Insight reports that money flowing into bond funds is on a pace to exceed $300 billion this year, exceeded only by the record $350 billion that flowed in last year.
And the U.S. Federal Reserve continues to re-invest billions in Treasury bonds every month, using the interest it’s earning on the massive amount of bonds it bought last year in its first round of quantitative easing.
It begs the question, who is doing all the selling that’s driving bond prices down, the supply they’re feeding into the market overwhelming the exuberant near-record buying of investors, and the continuing buying of the Fed?
Could it be central banks, as in China and Japan, holders of such a large percentage of U.S. bonds? Analysts have long wondered how those nations would ever be able to downsize or diversify their U.S. bond holdings without devastating markets. Perhaps by selling into the strength being created by the unusual buying of investors and the Fed?
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