Charting Treasury Reactions To Prior QE Episodes

Today the Fed may or may not announce a new outright dollar debasing venture, or may merely hint one is coming. And while the impact on stocks is pretty binary (post embargo, break stocks will either surge or slump) as very few are left trading equities, the real question is what will happen to rate and rate derivative products. Conveniently, Morgan Stanley's Igor Cashyn has compiled a historical analysis of how prior episodes of QE have impacted Treasury-based products. Igor looks at front and back-end rates, at curves, butterflies, swap spreads and agencies. Here are the results.

As Cashyn prefaces his report: "In the chance that something does get announced today, this report offers the guidance to what we can expect based on historical market reactions" and here are the products that readers can decide offer the best bang for the buck should QE2 come:

In front-end rates: The impact should be minimal, even as it has been quite bullish before.

In back-end rates: 10y USTs rallied 24bp, 51bp and 7bp on the day LSAPs were announced in 2008, 2009 and 2010. If LSAPs are resumed, we can retest the 2.50% resistance level – a fair outcome, in our view. If no new LSAP language is added, however, the market is likely to be disappointed, and may reduce the probability of the Fed acting in November as well.

In curves/flies: 2s10s flattened a consistent 26bp, 22bp and 25bp in the week after the ‘08, ‘09, and ‘10 LSAP announcements, respectively, while 10s30s tend to steepen initially. Belly tends to rally, led by 7s.

In swap spreads: 7y and 10y spreads widened 13bp and 8bp, respectively, the day UST QE was announced in 2009 (albeit they were quick to revert). Given how narrow spreads are now, however, putting on wideners is a good way to hedge the initial move, in our view.

In Agencies: Spread moves are unlikely to be large, although they may lag any move in Treasuries.

And here is how it looks in all its graphic splendor:

Treasury Benchmark:

Treasury Curve Switches:

Treasury 50/50 Butterflies

Treasury PCA Butterfly

Treasury Swap Spreads

Agency Spreads

Comments

[TWORIVER]

The market is likely to do any appreciable trading up until 12pm, when the pre FOMC quiet will set in. The last meeting produced relatively tight trading at range highs after the announcement, followed the next day by the beginning of a 7% decline. Should be an interesting end of the day.

[99er]

Chart: ES and ZB

The writing's on the wall.

http://www.screencast.com/t/NWRiZDUzMj

http://99ercharts.blogspot.com

[SheepDog-One]

Hey Ben if the recession is over, housing starts soaring and all is well in La-La Land, then raise rates set it at 3% this afternoon! Come on, just a measely 3% historically its still low, lets see you dare to ever budge this crap off of -0-!

[hedgeless_horseman]

And while the impact on stocks is pretty binary (post embargo, break stocks will either surge or slump) as very few are left trading equities, the real question is what will happen to rate and rate derivative products.

Q: Who run Barter Town?

A: Master-Blaster:

http://static.guim.co.uk/sys-images/Guardian/Pix/pictures/2009/03/24/geithnerbern460.jpg

[theyenguy]

Tyler you relate that this report will provide "guidance to what we can expect based on historical market reactions."

It offers "No Practical Guidance" as I have no idea any of the metrics mean. Perhaps this report should be filed away in a file cabinet on Wall Street; yes like taken off your website.

The report offers no tradeable insight. In other words, a common person, who looks at this is utterly confused and would have to rely on the "expert's advice" for trading -- not a good thing as one should be able to come to an investment decision without having to be spoon fed by an analyst.  

Here is perhaps some more practical analysis: "On August 31, investors sold out of Bonds, BND, which included ZROZ, and BLV, in response to the August 10, 2010 announcement by Fed Chairman Ben Bernanke to buy mortgage backed securities. Investors see the announcement as monetization of debt, and the market place called a defacto interest rate hike. The 30:10 Yield Curve, $TYX:$TNX, is now flattening. This will operate for years to destroy bond wealth bond in the public and private sectors.

Junk bonds, JNK, which have been leveraged up by abundant credit liquidity and yen carry investing of all sorts trading at an all time high. And these will be trading down when carry trades like the EUR/JPY fall lower."

[Cruel Aid]

On BND, It plunged from 83 to 82 and continued the trend.

It is kicking Cashes ass for the last year in the pseudo fixed world and back above the 50 day.

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