Goldman Attempts To Answer The $2.9 Trillion Question: "What Happens When The Fed Stops Buying?"

Tyler Durden's picture

Goldman's just released look at what the end of QE2 would mean should certainly be taken with a grain of salt: after all lately (and in general), the firm's sellside recommendations traditionally are a gateway for its own prop traders to take the other side of what its clients are doing (observe recent performance in WTI). That said, probably the most insightful piece of data is that we now know what the upcoming Greece bankruptcy will be called in polite circles: wait for it - a "liability management exercise." As for the overall impact on rates, Goldman is not surprisingly bearish on rates, and sees the bulk of the upcoming weakness as focused on the 5 Year point. Franceso Garzarelli summarizes his view as follows: "together with our forecast of above-trend growth in coming quarters
and the idea that the compression of bond premium will decay as the
Fed’s balance sheet (organically or voluntarily) shrinks, we think that
short positions in 5-yr Treasuries remain attractive."
In other words, Goldman is expecting some flattening in the short end. Does that mean a steepening is inevitable. As for the broader perspective on the curve, Goldman says: "assuming the Fed’s bond holdings passively run off as securities mature, the bond premium should gradually rise. And our macro forecasts are consistent with higher real rates in coming quarters." In other words, another extremely non-committal report from a firm that is rapidly losing its Master of the Universe status. Key highlights below.

  • Concerns that a combination of higher energy prices and fiscal tightening will dent growth have supported global bonds. These concerns are overstated, in our view. Meanwhile, core inflation has turned (admittedly from low levels), and more European central banks are likely to follow in the ECB’s footsteps and tighten policy over the coming months.
  • Our estimates indicate that ‘QE2’ could have shaved as much as 40-50bp off intermediate US bond yields. The effect of purchases is most visible in the 5-yr sector of the Treasury curve, which continues to look ‘rich’ relative to 2s and 10s.
  • When the flow of purchases ends in June, there should be little immediate effect on bond yields—provided expectations are that the Fed will not sell securities back into the market any time soon.
  • However, even assuming the Fed’s bond holdings passively run off as securities mature, the bond premium should gradually rise. And our macro forecasts are consistent with higher real rates in coming quarters.
  • In Euroland, Portugal formally requested conditional financial support and talk of a liability management exercise on Greek sovereign debt has intensified. Although the latter could lead to bouts of risk aversion, we continue to expect further spread compression between the larger ‘non-core’ issuers (i.e., Spain, Italy and Belgium) and Germany/France.

And the full report:

What Happens After the Fed Stops Buying?

The Fed’s QE2 program could be keeping intermediate maturity US Treasury yields around 40-50bp lower than would otherwise be the case. The effects of the central bank’s purchase are most visible in the 5-yr sector of the yield curve, which still looks ‘rich’ relative to adjacent maturities. When the flow of purchases ends in June, and on the assumption that the stock of bonds held by the Fed does not change, there should be little immediate effect on bond yields. Nonetheless, the ‘term premium’ should gradually rise as the Fed’s bond holdings passively run off as securities mature. Moreover, expectations of the Fed selling securities back into the market—which is not our baseline case but could admittedly pick up as the economy continues to recover—could amplify the increase in yields we expect based on our macro forecasts.

Fed’s Bond Purchases Soon Drawing to an End

Through its asset purchase program (‘QE2’), the Fed has delivered a stimulus to the economy by-passing the nominal zero policy rate constraint and influencing directly longer-dated discount factors. In the December issue of our Fixed Income Monthly, we estimated the Fed had broadly succeeded in bringing intermediate and long Treasury yields close to a level consistent with negative policy rates as implied by a ‘Taylor Rule’.

As the purchase program draws to an end in June, we are frequently asked whether there will be an adverse impact on the bond market. We tackle this issue with an ad hoc regression analysis, cross-checking our findings through the suite of valuation tools we regularly employ in the formulation of bond strategy.

Our main conclusion is that the announcement of the total size of Treasury purchases, rather than their implementation, could have lowered intermediate maturity Treasury yields by as much as 40-50bp. As long as the Fed does not announce its intention to sell bonds back into the market any time soon (which continues to be our baseline case), this effect is likely to fade only gradually, assuming no intervening change in the macro landscape.

Our central forecasts, however, are consistent with a progressive increase in real bond yields over coming quarters. And, as the recovery takes hold, it is conceivable that market participants’ expectation of asset sales could increase, thus amplifying the sell-off in yields. With this in mind, we continue to recommend short positions in the 5-yr area of the Treasury curve, which looks to have been the most influenced by the Fed’s interventions.

The ‘Announcement Effect’

Assuming financial markets are liquid and forward-looking, bond prices should be affected by the announced total amount of purchases the central bank intends to conduct, rather than the subsequent flow of purchases. Chairman Bernanke has been among the proponents of this approach, which researchers often refer to as the ‘portfolio balance channel’ or the ‘stock view’.

If this theory is correct, when the flow of purchases is discontinued there should be little effect on yields provided expectations are that the Fed will not sell securities back into the market any time soon.

Empirical evidence appears to support the notion that the ‘stock’ effect dominates the ‘flow’. For example, 10-year US Treasury yields fell sharply following the surprise announcement of the ‘QE1’ program on November 25, 2008 and March 18, 2009. However, there is little evidence that yields increased following the termination of those purchases at the end of October 2009 (when the Fed stopped buying Treasuries) and March 2010 (the end of the mortgage-backed security purchase program).

The chart at the bottom of the previous page compares actual 10-yr US Treasury yields with the ‘fair value’ implied by our Bond Sudoku model. The latter describes US bond yields as a function of 1-yr-ahead consensus expectations on short rates, real GDP growth and CPI inflation, both domestically and in the other major advanced economies. The effects of the asset purchase program (or shifts in the net supply of government bonds) are captured by the model only indirectly, i.e., to the extent that these influence expectations on the future course of the relevant macro factors.

As can be seen, ‘QE1’ led to a fairly rapid move in bond yields right on the announcement date. In the case of ‘QE2’, the effect largely preceded the FOMC meeting in which the decision was taken. This can be attributed to the fact that, in a number of speeches through the Summer, Fed officials had hinted at a resumption of bond purchases to stimulate the economy.

By the time the Fed announced the intention to further expand its balance sheet on November 3, 2010, 10-yr government bonds were already trading around 1 standard deviation (or roughly 40bp) below their macro equilibrium. Our GS Curve model—which links the term structure of constant maturity Treasury yields to consensus macro expectations at different horizons—indicates that around the same period bond yields in the 5-to-7-yr maturity range (the main target area of purchases) stood at very depressed levels relative to their historical relation with the 2-yr and 10-yr sectors (see chart below).

Once again, most of the effect precedes the actual decision to conduct asset purchases, but expectations of such an outcome had been building ahead of the FOMC meeting. A parallel can be drawn to the Fed’s decision to cut policy rates to 1% on June 25, 2003. Intermediate maturity bonds rallied strongly in the 3 months before the policy meeting, only to sell off aggressively after the event.

Fed Holdings Keep Bond Premium Lower

In order to test the empirical validity of the ‘stock view’ more formally, in previous research Jari Stehn ran a regression between the nominal 10-year US Treasury yield against four factors: the stock of announced purchases, the actual weekly flow of these purchases, a number of economic variables (including payrolls, the ISM survey and the University of Michigan/Reuters 5-10 year inflation expectations) and measures of the Fed’s other unconventional monetary policies (such as its guidance that it would keep interest rates “exceptionally low for an extended period”). The results, summarised in the first column of the table above, indicate that the effect of the announced stock of purchases is negative and statistically highly significant.

One issue with this simple specification is that the coefficient on the flow of purchases takes the ‘wrong’ sign, suggesting that the flow of purchases raised bond yields. This counterintuitive finding has a simple explanation: just about as the Fed started to purchase assets last November, bond yields rose sharply because growth expectations improved and, partly as a result of this, market participants revised down their expectations of further easing. But because the statistical exercise controls for the contemporaneous rather than the expected macroeconomic landscape, the increase in yields is attributed to the flow of QE2 purchases.

To address this shortcoming, rather than focusing just on the 10-year yield, we explore how the Fed’s purchase program has affected the yield curve across maturities. This allows a differentiation between the impact of economic factors (which affect the entire term structure) and the Fed purchases (which could differ by maturity bucket). Making use of the relative movement of yields at different maturities provides more information and should therefore provide better identification.

The Box above outlines the approach we have taken and the main results are summarised in the second column of the table on the previous page. Once again we find a significantly negative and economically meaningful effect from the stock of purchases on the 2-10-year part of the yield curve, while the coefficient associated with flows is now insignificant. Specifically, the estimates suggest that yields in the 2-10-year maturity range have been reduced by around half a basis point for each US$1bn of announced purchases. This suggests that the Fed’s Treasury holdings could be currently holding down 10-year yields to the tune of 40-50bp. This numerical result is clearly subject to the usual caveats applicable to the outcome of statistical analysis, but is reassuringly not far from what other studies have found. In addition, similar regression analysis on 10-year yields for the UK also found a significant and meaningful effect from the stock of purchases but not from the flow of purchases (for more details, see “A Modest Impact on Markets from the End of QE2” Global Economics Weekly 11/14).

To Sell, Or Not to Sell?

The empirical analysis reviewed so far allows us to draw the following conclusions for bond strategy:

  • The starting point for 10-yr US Treasury yields is not far from a notion of ‘fair value’ consistent with the historical relationship to the current set of consensus expectations on macroeconomic factors. Going by this result, longer-dated US nominal bond yields are not abnormally low relative to where the average investor expects the economy to be heading. Rather, they do not incorporate the additional premium that is typically in place when the monetary policy stimulus is at full throttle.
  • Expectations on what the Fed will do with its bond portfolio—hold on to securities until maturity or sell them beforehand—matters more than the distribution of flows. So, whether purchases are tapered off or ended on schedule should have little effect on bond yields. Put differently, no ‘cliff effect’ should be expected at the end of June.
  • Our central view continues to be that the Fed will not announce asset sales for a long time to come. That said, even assuming the Fed’s bond holdings passively run off as securities mature, the term premium compression we have identified through our empirical work should gradually decay. Moreover, as the economy continues to expand along our baseline forecasts, it is plausible to think that investors’ expectations could shift towards assigning a larger probability to asset sales. This would amplify the underlying tendency for bond yields to rise.
  • According to our GS-Curve calculations, the 5-yr sector of the Treasury curve has not completely realigned itself to its historical relationship with shorter- and longer-maturity bonds, conditional on consensus views on how the US economy will perform over different time horizons. In light of this observation, together with our forecast of above-trend growth in coming quarters and the idea that the compression of bond premium will decay as the Fed’s balance sheet (organically or voluntarily) shrinks, we think that short positions in 5-yr Treasuries remain attractive.


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Silver Bug's picture

Basically, the game of musically chairs comes to a end. And we quickly realize. There just isn't that many chairs. It won't be pretty. Better have your Gold and Silver for that Hurricane.

camaro68ss's picture

Is this serious or am I suppose to laugh because I’m laughing right now.

We are all fucked

MarketTruth's picture

Who is this 'we' you talk about? Only the stupid sheeple will be left as bag holders as physical gold and silver holders will have the security of not seeing their hard earning being inflated and devalued away.

camaro68ss's picture

 I hold silver, I just talking in general

cranky-old-geezer's picture

Not exactly. 

PMs aren't the only way to store wealth safe from currency debasement.  There are other ways also.

But we agree that any dollar-denominated asset will lose value as the currency looses value.

Michael's picture

Get this strait you fucking morons, not you MT; It is impossible for Ben Bernank to stop QE to infinity, for the exact second he does there will be an immediate complete and total worldwide economic collapse of biblical proportions that will make the great depression look like a fucking picnic. Got it?

Popo's picture

So you're saying at the cusp of our deflationary implosion you should buy metals?

redpill's picture

Actually I don't think he's really saying anything, he's typing some words and pasting a link to his blog.

But to your point, typically a deflationary environment would result in a rush to cash as a haven, but with the current dollar devaluation situation, we may see a reversion from the historical norm and witness PMs resist the decline because they have begun to supplant the dollar a crisis shelter.

cranky-old-geezer's picture

But there won't be deflation. 

Inflation is baked in now.  To keep the federal govt operating if no other reason.

Ned Zeppelin's picture

Be ready for the 180 degree head fake.  I think it may be coming. Engineered from the very top.  

JFK.4PREZ's picture

I agree- IMO no immediate QE3.  Banksters want to see a sell-off in PMs and commodities.  They may be shorting them on one side with fiat, but I wouldn't be surprised if theyre buying out the other end (for personal gain).   fucking douche magooshes.  But right before SHTF - helicopter ben will fly by with money bags for all!   QE3 YAY!  

Where's the best place to get a degree in Ponzinomics?  Princeton?

MadeOfQuarks's picture

Yep, could definitely happen. I purchased a fairly large amout of cheap stock puts to hedge my silver, could be worth considering.

long juan silver's picture

Dont expect change from your GOLD eagles when I sell you a ham sandwich.

Max Hunter's picture

Pre 65 quarters and dimes will be quite suitable in most cases.. Not to mention, most people with PM's also have food and other necessities stocked up as well..  I wouldn't be holding my breath waiting for someone to offer you a gold eagle for that ham sandwich..

Cleanclog's picture

VIX just dropped to 14.99. Is anyone REALLY asking any questions? Suggests all is just dandy. Japan, Euro debt, future earnings, consumer purchases, or is it all just US dollar dropping so prices all look better?
Goldman doesn't answer client questions. They profit off their guidance to clients when they go the other way.

SheepDog-One's picture

No one is actually in the markets except for the 401K zombie brigades, totaly asleep after seeing some not so terrifying statements in the mail. All is well for now until placating the 401K zombies is no longer beneficial to banksters.

Misean's picture

My guess is the palcation is to roll through the next election cycle. Get the Baby bumblers another year toward exhaustion and age. Leave them hopeless, hungry and terribly frightened...

SheepDog-One's picture

I dont believe they can buy another calm 18 months with all the money they could print day and nite. Within a couple months, rocketing food prices, $5 gas, and a dollar that wont buy you what a nickel used to buy. Election schmecktion.

Misean's picture

I think they're gonna try...doesn't imply success.

Ned Zeppelin's picture

oh, and ever more heavily armed. . . . 

10kby2k's picture


Market closes daily where it was after 30 minutes of trade. No intra day action....let alone intra day reversals.  With all the obvious problems the economy faces....this is astounding. I've never seen anything like this.  Do all the trading desks have the same software? or is there a conspiracy? or both?

NotApplicable's picture

They are all operating on behalf of the Fed.

All hail the POMO.

American idle's picture

Empirical evidence?

KTAISA's picture

is the answer yes?

Boilermaker's picture

REITS just hit a 52 week high and up AH just make sure you don't dare fucking think about shorting those steaming piles of shit.

What difference does this garbage even make anymore?

Seriously, this has just become a pathetic comedy at this point.  Nobody believes it.  Nobody will believe it.  Slamming this shit even higher isn't going to convince anyone either.


SheepDog-One's picture

At this point its all they can do. As an earlier article mentioned their only game now is get thru today, and probably tomorrow...after that who cares. Its total lunatic policy at this point.

Boilermaker's picture

I suppose so.  The comedy of it is that you can't hide the sale of CRE, it's publicly available.  Yet, they'll just slam it higher and higher anyway.  In some ways, the worse it gets the more they jack it higher.  I guess it's to force 'maximum pain' on anyone that dares to try to capitalize on the stupidity of it.

In any event, it's just fucking pitiful now.  But, as always, there are some stump-jumping fucking idiots that will buy into it.  So, what the fuck ever.

A Man without Qualities's picture

As I have said before, the bankers were fond of selling these things to pension funds.  

Quite often they'd sell the properties owned by the public sector, then arrange a sale and lease back and sell the equity from the REIT to the pension fund of same public sector.  It was a very lucrative racket for the banks, but obviously, they're terrified if it generates losses for the fund.  The idea that a government entity sells a building for a grossly inflated value to their own pension fund and pays the banks about 10% in the process doesn't look good, so the easiest thing is keep it propped up and hope nobody notices..

Matto's picture

It used to be you'd have to say something truly ludicrous to junked around here - there was space for all comments and all points of view. Look at it now, cant believe people junked your comments, whether they agree with them or not.


Pull your fkn heads in junkers - if you're gonna run around junking everything then provide an explanation & add to the discussion at least!

Ned Zeppelin's picture

Noticed the junker assholes are on the increase. Pay no attention.  

fxrxexexdxoxmx's picture

No one will go to jail as a result of banksters, unions, and public workers greasing their pockets.

No one will go to jail.

What have they got to fear? The MSM will blame Bush and Zero will win the next election.

F***king Republicans........../s

Boilermaker's picture

Are you short several dozen IQ points?

Bear's picture

Why not AAPL when you are at it

hedgeless_horseman's picture

Boilermaker, as you and I have discussed before, most apartment REITs should continue to do well, so long as more people continue to rent apartments.

Boilermaker's picture

SPG, VNO, and BXP are not apartment REITs.

hedgeless_horseman's picture

Three of thousands, a minority, and you never specify, but rather always generalize.  Were you victimized by a bad REIT deal as a child? 

Speaking of victims, listen to this stuff:

Boilermaker's picture

I'm not referring to the 'thousands'.  I'm referring to the giants which is what the Fed is monkey hammering higher every day.  Those are SPG, VNO, BXP, and GGP -OR- IYR and RMZ in ETF form.

I'm just fine.  I'm just so damned interested for anyone to justify the valuations and / or daily cornhole-the-shorts action.

I guess it could be organic buying from retail investors <barf>,

unununium's picture

I have lost a chunk of change shorting VNO but your idea sounds intruiging.

I think I could drink one little drink and if it doesn't work out, that would be it forever.  Just one little drink.

sunkeye's picture

@bolier that's the thing it makes no sense yet it continues

SheepDog-One's picture

Go ahead clowns, end QE, I dare ya! Damned if they do, more damned if they dont...and the realization when the music stops that theres only 1 termite eaten chair available and GS has dibs on it wont make for a very nice scene.

Practical Irrationality's picture

Great write-up on what would happen IF the Fed stops buying.


The Fed will never be able to stop buying.

SheepDog-One's picture

Well they dont just keep buying to infinity. This game is on a timeline, it must end at some point.

Misean's picture

What happens? Cascading cross defaults. What does this BS from Goldman Sucks mean? Positioning the rubes for a buying frenzy from the squid at the end of QE2 before QE3 is announced. Of course Goldman Sucks has no inside information and has NOTHING to do with Feral Reserve bosses...

Sudden Debt's picture



zaknick's picture

Aren't "conspiracy theories" fun???

Henry Kissinger, together with his international political directorate known as Kissinger Associates, is the individual who stands at the intersection point of every one of these networks: the back-channel with the Soviet Union, the drug and terror networks from Italy to Ibero-America, and the highest levels of finance, including his directorship in American Express, the entity into which has merged a major portion of Dope, command structure.

This command structure contains the following main groups:

* The British combination that controls offshore banking and precious metals trading, i.e., the Hongkong and Shanghai Bank, the Oppenheimer gold interests, top British financial institutions such as Eagle Star Insurance and Barclay's Bank, and their Canadian cousins such as Bank of Montreal and Bank of Nova Scotia;

* The major Swiss banks;

* The continuity of Venetian-Genoese financial manipulations in the personage of the late Roberto Calvi of Banco Ambrosiano, and the shadowy Edmund Safra of American Express;

* The combined offspring of the Swiss bankers and the old European fondi, the international grain cartel of Cargill, Continental (Fribourg family), Bunge, and Louis Dreyfus;

* The Boston Brahmin families and the big American financial institutions associated with Henry Kissinger, including Citibank, Chase Manhattan Bank, and American Express.

We identify a tightly closed financial network whose origins lie in the Dutch and British East India Companies and the modern origins of the narcotics traffic in the British Opium Wars of the 1840s. The paradigm for this network is the London Committee, or British-based directors, of the Hongkong and Shanghai Bank, the central bank for Dope, Incorporated. It ties in directly and immediately to the five big London clearing banks, the five London "gold pool" dealers, and the big Canadian international banks.

This network provides the offshore banking, precious metals, and related capabilities to cause several hundred billion dollars per year to disappear from the streets of New York, Amsterdam, Frankfurt, and Hong Kong, and reappear as apparently legitimate assets wherever convenient. We showed further that Anglo-Chinese collaboration in the Asian opiates traffic was a matter of official policy on the part of the People's Republic of China, and "business arrangements" of the British elite dating back to the first corruption of the Imperial Chinese bureaucracy by the British East India Company.

The Oppenheimer mining group, heirs to the empire of Cecil Rhodes, is the dominant force-in collaboration with HongShang and its Mideast subsidiaries-in the illegal traffic in gold and diamonds through which so much dirty money is turned into untraceable, portable assets. Through its diamond monopoly, De Beers, its mining corporations, Anglo-American Mining and Consolidated Gold Fields of South Africa, through its commodity trading organization, Phibro, the Oppenheimer group has expanded its tentacles across the world and, most of all, in the United States.

The old United Fruit Company, renamed United Brands in the 1960s, has been the center of American organized crime since the turn of this century ... United Fruit's banana boats coming into Baltimore harbor have been the freest vehicle for the physical passage of contraband into the United States. In its successive corporate reorganizations, United Brands has since wound up in the hands of Cincinnati, Ohio insurance financier Carl Lindner, the principal business partner through the last three decades of Michigan organized crime heir Max Fisher. And through an entanglement of financial interests that might have been invented by a gaudy but unimaginative mystery novelist, the fate of United Brands has been intertwined with that of American Express, the world's most efficient silent money-mover, and the prince of Levantine money-laundering, Syrian-Swiss financier Edmund Safra. American Express, the monster that devoured half the old great houses of Wall Street, ties together the United Brands crime and smuggling capability, the financial networks who created and funded the Argentine Monteneros and other terrorist organizations, as well as the Swiss-based interests who have acted, for a generation, as the private couriers of the Soviet Union in the international gold markets.

Investment banking in the United States is now almost wholly controlled by the ancient European fondi, that is, family trust funds whose pedigree goes back to the financing of the Crusades by Genoa and Venice.

From 1971 to 1981, in the decade after then-Treasury Undersecretary Paul Volcker removed its gold backing, the U.S. dollar fell to a mere 60% of its pre-devaluation level, while the combined effects of inflation and lower stock prices devalued American equity to about 30% of its 1971 level in terms of gold. From the standpoint of the old oligarchical fondi, secured through gold, American equity could be had for a fifth of its pre-1971 price during the late 1970s.

magpie's picture

There have always been conspiracies, but most of them fail.

That's the theory.