If FED tipped their hand saying they will buy billions in bonds every month, then why did bond prices fall during this period of massive buying intervention? The "obvious" trade would have been to hold on to bonds until price went up from FED buying then dump them. However bonds sold off immediately and anyone holding on to bonds waiting for prices to go up were left holding the bag as prices kept going lower for months and months amd months. Example QE2 Nov 2010 Interest Rate: 2.76 Then December: 3.29 January 2011: 3.39 Feb: 3.58 Mar: 3.41 (ticked down) Can anyone explain the mechanics of why this happened? That interest rates would rise when FED says they're going to force it lower?
It's the purest evidence there is that investor expectation dominates as a price determinant, not the flow so much. Remember the supply available to a market at any time is outstanding stock/inventory of treasuries (total outstanding) + marginal flow. You can see even with $45B a month of QE3 how that pales in comparison to the $12T of outstanding public debt (subtract a few $T of that for the Fed ...). Back in those days, once QE2 was churning along, the economy happened to recover a bit and inflation expectations rose. Inflation expectations, real rates, and term premiums are combine to determine long term bond prices. Bernanke says it best: http://www.federalreserve.gov/newsevents/speech/bernanke20130301a.htm Despite the Fed and researchers trumpeting that QE had/has an effect to lower rates based on flows, Bernanke contradicts that here. The expectations from the policy should dominate. Japan right now is an opposite case. Their flow seems to be successfully dominating for now... Right now, bonds are falling not based on flows, but based on growth expectations (which drives real rates and inflation expectations) which justify an exit to the QE. But its not the stoppage of bond buying that is driving the price down; its the answer to this question: 'Why would you want to tie up long money at low rates when a faster growing economy will yield MORE project opportunities that yield better returns than right now' ? You have to admit, the strength in October data despite the shutdown is a positive.
1) The FED is the buyer of "last resort". If ever they don't want bonds, be careful of the downside. :eek: 2) Buy the rumor, sell the fact. :eek: 3) The decline can be indicative of pending deflation. There will be no "safe harbors" nor "flight to quality" because everything will have turned into garbage, even gold. :eek: 4) The FED can appear to be "competent" during bull markets but bear markets show them to quite the opposite.
The law of supply and demand holds in all markets as was stated above. For the Fed to buy someone else has to sell. Some groups believe the longer term outlook of US is looking bleaker as time goes on. The truth or falsehood of this view is not relevant. What is relevant is that if those who had accumulated the bonds over the years believed it to be true, they would want to get rid of these bonds and protect their principal. If they did that without having a strong buyer, the price would have dropped precipitously making the yields go through the roof. This would have made the recovery of the principal problematic. Fed now steps in and declares their intent to support the bond market. Those holding on to their bonds and sweating have a guaranteed strong buyer with deep pockets available for now. What do they do? They get rid of the bonds as fast as they can, before the other holder does. The Fed is providing the demand, while the previous bond holders are providing the supply. The net effect is that the supply is stronger than the demand, even though the demand is provided by the Fed. Had the previous bond holders wanted to hold on to the bonds, the new demand generated by the Fed would have probably lifted the price. Then again, if owners really want to hold on to the bonds, the Fed wouldn't have had to provide support in the first place. The fact that Fed had to intervene shows that the supply of bond in the market was increasing rapidly enough to cause Fed to act. Intervention by Fed didn't prevent yields from rising, but probably slowed their rise, leading to the seemingly paradoxical result of bond yields rising on Fed buying. Gringo
The Fed is NOT buying. They are SELLING as many bonds as they are buying so the net effect is neutral. They are actually trying to manipulate the curve, not nominal rates. And even on the parts of the curve where they look to be a buyer, size always sells into size. Or we use to have a saying on the trading floor, size attracts size. If there is a size buyer in AAPL, the ES or the Yen, rest assured a size seller will be there to meet it. Same for a size seller. Or put another way, liquidity attracts liquidity.
I dont remember the specifics of that time but just say we were coming out of a flight causing Europe crisis , and, fed QE2 plans were thought to be inflationary at that time, and, we were juiced on Jackson Hole 1 for a risk on rally, then treasuries could get dumped at some stage of pre or actual QE2. Maybe after that a combination of stated fed intentions and actions along with strain from euro crisis and US downgrade(yeilds still fell) had bonds bid solidly up to the wiff of taper and here we are. This is maimstream financial story / talking point media stuff that i get after the fact so who knows. I have learned in the last couple years to expect change, and not to depend on cause/ correlation. Specifically as in stocks/bonds or dollar/bonds and so on.
I wonder if strength of auctions has any predictive value or merely reflects current rates and sentiment... Hmmm.