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 Curve Switches:
Treasury 50/50 Butterflies
Treasury PCA Butterfly
Treasury Swap Spreads