2 Year At New Record Low Yield As Fed Now Expected To Use Mortgage Prepayment Cash To Buy Treasurys
Jon Hilsenrath is out with the latest rumor of what the Fed will decide to do to stimulate a double dipping economy next week, and while it is already well known that Bullard is all for QE 2, and the idea of reducing the interest rate on excess reserves has been widely pondered and for now at least, snubbed, the WSJ confirms that the latest plan is to use proceeds from maturing mortgages to buy treasuries. The result: a 2 Year that is at a fresh all time record low yield of 0.542%, and a 10 Year flirting again with the 2.9% barrier. Stocks and bonds are once again terminally disconnected, as the market attempts to front run the Fed in buying up Treasuries, even as the marginal buying is occurring in stocks since the Fed has essentially announced that anything yielding less than 4% is risk free. Of course, as Jon points out: "Any change—only four months after the Fed ended its massive bond-buying
program—would signal deepening concern about the economic outlook. If
the Fed's forecast deteriorates significantly, it could also be a
precursor to bigger efforts to pump money into the economy...The Fed's mortgage buying pushed investors to buy other assets,
including corporate bonds and stocks. Any extension of that program,
even in the form of reinvestment, could help support the recent rally
in such riskier assets." So can we at least stop pretending the economy is not double dipping and that stocks are in way even remotely indicative of fundamental values. Tangentially, and as frequent readers will recall, any message from the WSJ is very likely to have had the prior stamp of approval of the New York Fed, implying it is vastly more than mere speculation.
With bond yields already at near record lows even without the benefit of Bernanke, one wonders how soon before we see 1% on the 10 Year:
Buying new bonds with this stream of cash from maturing bonds—projected at about $200 billion by 2011—would show the public and markets that the Fed is seeking ways to support economic growth. It could also be a compromise that rival factions at the Fed support, as officials differ about whether and how to address a subpar recovery.
Whether the Fed makes any move next week depends in large part on economic data, particularly the government snapshot of the jobs market due Friday. Since Fed officials last met in June, data on consumer confidence and spending have softened and job data haven't improved. But overall financial conditions have improved somewhat, with a rebounding stock market.
Um, no. Financial conditions have deteriorated as evidenced by the ongoing lack of credit where it counts as well as the 3 month deterioration in European overnight lending, indicative that absent the ECB's explicit backstop of everything, the European financial system would be dead right now.
Regardless, we can't wait to hear Hoenig's response: it would be quite amusing if the Fed president would resign in protest to this latest monetary insanity (just look at the EURUSD at 1.323 for confirmation).
Officials in the Fed's anti-inflation camp aren't convinced the economy is slowing significantly and are wary of taking new actions. Others are eager to consider new steps to address recent signs of a slowdown and persistent high unemployment.
Fed officials aren't yet prepared to take the larger step of resuming large-scale purchases of mortgage-backed securities or U.S. Treasurys. But they are holding open that option if the economy deteriorates. Private forecasters generally expect real GDP to grow by an annual rate of about 2¾% in the second half of 2010. If the picture deteriorates and they forecast growth falling below 2%, the Fed would be more likely to act.
One thing is certain: we will never see an orderly Fed rate increase in this lifetime. The next time the Fed is forced to hike rates will be after the tipping point of hyperinflation has come and gone, and as always, the Fed will be forced to chase market reality from a reactionary stance.