The end of QE2 & Bonds

Out of curiosity, how do you guys think the end of QE in June will affect are going to affect treasuries & the bond markets in general? Are yields really gonna go up as Pimco and Bill Gross predict, is this already priced in? Treasuries are yielding negative real returns nonetheless in the US, so what markets do you guys like?

IMO, the combination of (1) an anticipated dollar depreciation and (2) a lesser capacity of foreigners (Japan, China) to buy long term treasuries will cause long term rates to jump. No one wants to jump on that grenande.

Also, when the money supply jumps the way it did, yields eventually HAVE to catch up

It’s hard to see exactly how rates won’t go up if [Fed] demand for the stuff slackens. There is a chance that they will go up so quickly that industry will grind to a halt and then we’re back to deflation again, which would contain the rate rise because everything else may start to collapse, making bonds seem attractive again, but even that seems unlikely with all the cash on corporate balance sheets (my take on that is that it’s there precisely so that companies reduce their dependence on bank lending).

Money will flow out of risky assets and into bonds. QE2 has pumped up the stock market and commodities, when it is removed those funds will go elsewhere, including treasuries.

equity_analyst Wrote: ------------------------------------------------------- > Money will flow out of risky assets and into > bonds. > > QE2 has pumped up the stock market and > commodities, when it is removed those funds will > go elsewhere, including treasuries. Only if the yields are attractive.

Very hard to say. If you think rates are going up, that’s going to whack both stocks and bonds. The strategy is to sell stocks now, hold 90d T-bills and then reallocate after rates have risen. How you allocate between stocks and bonds afterwards depends primarily on what happens to the equity risk premium, and secondarily on how your return objectives have changed. For example, you might allocate to bonds simply because yields are now high enough to meet (or better meet) your return requirements. Or you might allocate more to stocks because people will be scared after stocks have dropped and therefore the equity risk premium will be higher. So there really are so many variables to track it really gets confusing, and if you think you have the surest answer, very likely you are forgetting something important. Nonetheless, working out some of the possible scenarios can be helpful.

Stocks & interest rates are not correlated.

Uh, stocks are high duration assets. But thanks for the info.

mp3bu Wrote: ------------------------------------------------------- > equity_analyst Wrote: > -------------------------------------------------- > ----- > > Money will flow out of risky assets and into > > bonds. > > > > QE2 has pumped up the stock market and > > commodities, when it is removed those funds > will > > go elsewhere, including treasuries. > > > Only if the yields are attractive. I’m staying away from bonds in general, but I’m inclined to agree with equity_analyst. QE was all about pumping up the prices of risky assets. Once it’s removed those asset prices could fall rather dramatically. As money flows out of risk, it’ll go into Treasurys. Even very little yield is more attractive than negative returns. So, I’ll go with rates go down. Still not buying though.

Bchad and everyone else, thanks for the inputs. Where would you guys position yourself in the yield curve? Assuming rates rise, Would it make sense to be in the short end now , then when yields are attractive again on US treasuries increase portfolio duration? I compared the yield curve in the US with the Brazilian, and while the US one looks pretty normally shaped, upward sloping, the Brazilian has a weird shape with what seems to be an inverted curve of maturities with 4 years and greater. What are possible explanations for that? Is it that the market does. Not expect further hikes from the Brazilian central bank in interest rates? Thanks for the patience everyone, this is coming from a guy who’s always worked on equity

Bonds could do down and yields up with less support from Gov… OR End of QE@ spooks markets, equities decline, people run to bonds for saftey…prices up, rates down. I am going with the latter.

i’m more inclined to agree that we will see a period of equity weakness. but that this weakness will be mainly due to the US housing market’s double dipping as a first order item and QE2 as a second order item (more of a momentum enhancing item). the purpose of QE2 was to simultaneously enhance the wealth effect through rising equity prices while lowering or at least restraining the increase of LT effective interest rates and mortgage rates (on net, as there will be obvious bond selling during a risk-on period). QE2 succeeded in boosting traditional risk assets but failed to lend much price support to the real estate market as mortgage rates rose 50 bps since the start of QE2 (due to an unprecendently risk-on environment where QE2 teamed up with great manufacturing and trade data) and house prices and sales suffered as a result. i think the effect of a continued decline in US house prices will wash away any wealth effect created from QE2 as it will once again begin to hurt household wealth as well as corporate operating wealth (increasing default rates, lower mortgage rates, less materials demand, etc). a continued decline (i.e. another major leg down in US house prices) would kill govt balance sheets and that would be your trigger for higher effective treasury rates.

I am thinking that after QE ends, substantial weakness in the Euro will encourage capital to seek out US treasuries or perhaps Chinese assets. SO interest rates may still stay relatively low.

The fiat price rise in equity assets due to money printing does not represent a true increase in wealth. Any such wealth effect derived from rising equity prices is illusionary and is not sustainable. We will not grow our way our of our debt problem and it certainly won’t go away simply because Netflix trades at a 200x PE. All the US and the rest of the world did is shift unrealized losses off the banks balance sheet and onto the taxpayers’ by creating money out of thin air. GDP here in the US is declining, even after trillions pumped into the system artificially. If the Fed stops buying treasuries who will be left to pick up the incremental supply? In all respects, Bernanke will go down as manager of the worlds largest hedge fund blow up of all time.

equity_analyst Wrote: ------------------------------------------------------- > The fiat price rise in equity assets due to money > printing does not represent a true increase in > wealth. I argue with ZHers all the time about this. It does actually result in increased wealth as long as it’s realized. Case in point, I just bought a new house and used proceeds from my investment portfolio for the down payment. That increase in my “paper” portfolio put a roof over my head. My investments increased in price vs a flat/declining housing market. I was able to buy more house. That is not an illusion. Over the long term, I completely agree with you though.

Sweep the Leg Wrote: ------------------------------------------------------- > equity_analyst Wrote: > -------------------------------------------------- > ----- > > The fiat price rise in equity assets due to > money > > printing does not represent a true increase in > > wealth. > > I argue with ZHers all the time about this. It > does actually result in increased wealth as long > as it’s realized. Case in point, I just bought a > new house and used proceeds from my investment > portfolio for the down payment. That increase in > my “paper” portfolio put a roof over my head. My > investments increased in price vs a flat/declining > housing market. I was able to buy more house. > That is not an illusion. > > Over the long term, I completely agree with you > though. Yes, but that is happening at the margin, as not everyone is able/capable of doing that. Furthermore, there is no free lunch since I would argue that in the aggregate the artificial wealth created, even if it is realized, like your example, is completely offset by the increased future liabilities which you will share in due to money printing. Case in point…Greece–citizens there are now paying the piper. In other words, the financial chickens are coming home to roost sooner or later.

the Greeks aren’t paying for fiscal irresponsibility, the Germans are. and the Americans won’t pay for fiscal irresponsibility, the Chinese and Japanese will. of course the Greeks and Americans will see pain when unemployment re-spikes, but it probably would have been worse if we honoured our debts instead of fooling our debtholders…

Good points.

It’ll be interesting to see what happens to Japan as they undergo their gigantic (even by our standards) round of debt monetization. QE for everyone! I think I’m going to buy some July SPY puts. QE2 will have ended, we’ll have three weeks of pain, and I’ll get to cash out right before The Bernake announces QE3.