Remember Quantitative Easing?

US Rates

Rates saw a dramatic rally last week primarily on the back of some significant policy announcements by the Fed. The US Central Bank suggested that it would re-invest the proceeds of more than $150bn from their investment in mortgage-backed securities into US Treasury notes and bonds. This is a clear change in policy stance from a few months ago, when the Fed was aiming towards a natural shrinking of its balance sheet. The Fed announced purchases of $18bn of Treasury bonds over the next month, much less than the average $50bn monthly purchases conducted last year as a part of the $300bn quantitative easing program. The purchases are expected to be in the 2 to 10y sector of the yield curve. Given that the Fed is reluctant to hold more than 35% of the market share in any one maturity, the pressure is mostly in the 5y to 7y intermediate sectors of the yield curve. The Fed also downgraded its economic forecast further accentuating the flight to quality move into Treasuries.

Yields on government bonds are now within striking distance of the all time lows seen in March 2009. The two year rate is already at an all time low near 0.6%.

Employment

This is after the prior week saw nonfarm payrolls for July decline by 131k vs. expectations of an increment of 100k. The only respite in the report was that most (if not all) of the job losses were from temporary jobs at the US Census. The employment rate, measured by the Household Survey held steady at 9.5%.

Currencies

In the obvious response, the US dollar faired quite well compared to other G10 currencies as investors moved to the shelter of US Treasuries. The Euro fell towards a three-month low in the 1.27 region. This move was also supported by the Q2 GDP report in the Euro area region which saw a robust growth of 2.2% in Germany on one hand while Greece was proven to be deep in recession with a negative growth of 1.5%. The market is set to re focus on the woes of the Euro area region.

What Lies Ahead?

One thing is certain; the next six to nine months are going to feel similar to the period from March to December 2009. The Fed is essentially elongating QE - at a smaller scale of course only because the economy is not in crisis mode. With an intent to buy $150bn of Treasury and an average of $18bn per month equates to 9 more months of wait and watch period. Whether the US goes into recession or not is difficult to say. Growth is going to be close to 0%! Be it is from the left hand side of the number scale or the right hand side. Well it’s not really surprising, what were the chances that the Fed would be able to pull-off an absolute smooth recovery in the first place. These obstructions were always on the cards.

With employment way above 9%, QE-like actions on the way, recession possibilities I don’t see the Fed hiking rates before this time next year, or perhaps even December 2011.