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Goldman Sachs Explains The Twofold Impact on Markets From The Fed's Pragmatism

Tyler Durden's picture




 

Goldman's European strategist, Francesco Garzarelli explains how he interprets the market impact from the Fed's QE lite announcement: First "the Fed’s actions will act to push real rates out to 5-yrs deeper in
negative territory (currently -8bp). We forecast that nominal 5-yr
yields could reach 1%. Factoring in positive foreign macro influences,
and accounting for an already very depressed bond premium, we believe
10-yr government yields could rally to 2.5%, but are unlikely to break
below this level on a sustained basis." Second:" we remain of the view that the pro-active stance of policymaking, in the
US and overseas (see Monday’s note on China by Yu Song and Helen Qiao),
should continue to support moderate returns on risky assets, as cash
balances become increasingly expensive to hold, and cyclical volatility
declines." In other words, buy stocks. It's good to see the leopard never really does change its spots.

Overnight, the Fed announced that it will aim to keep its total holdings of securities (currently around US$ 2 trn) roughly constant by reinvesting principal payments on Agency debt and MBS (of which it owns US$ 1.3trn ) into Treasury securities. Bond purchases ‘will occur across the entire coupon and TIPS yield curves’ but they will concentrate primarily on maturities between 2- and 10-yr. At 3pm NY time today, the NY Fed will announce the first tentative schedule of operations through mid September. Actual purchases will begin early next week.

Our US colleagues have commented on the Fed actions in their latest US Daily. From a market perspective, we see the relevance of this announcement as twofold.

Firstly, on a rough estimate (there are many imponderables in the calculation, including the level of yields and pre-payments – the lower yields go, potentially the larger the purchases, and vice versa), Treasury purchases will amount to around US$ 15bn per month for as long as the program is kept alive. Considering that this compares to gross issuance of Bonds and Notes (incl. linkers) of around US$ 150-175bn, and net issuance of around US$ 100-125bn, the direct influence on bond yields will likely be modest. To put these numbers in context, last year the Fed was buying US$ 40bn of Treasuries per month, in addition to GSE securities, admittedly amidst more widespread fears of ‘excessive supply’ than today.

Nevertheless, the policy reinforces the commitment to keep policy rates on hold by keeping excess liquidity in the money markets. Interestingly, the price action yesterday showed real rates rallying, and inflation breakevens widening. As we have said in our commentary, the Fed’s actions will act to push real rates out to 5-yrs deeper in negative territory (currently -8bp). We forecast that nominal 5-yr yields could reach 1%. Factoring in positive foreign macro influences, and accounting for an already very depressed bond premium, we believe 10-yr government yields could rally to 2.5%, but are unlikely to break below this level on a sustained basis. We do not see much room for breakeven inflation to fall, and we now think that 10-yr swap spreads will progressively widen to around 20bp by early next year, from around zero currently.

Secondly, the Fed has once again shown itself to be a pragmatic institution, ready to change course quickly in face of shifts in the macro economy. The expansion in final domestic demand and payrolls remains anaemic, and real GDP growth is losing the positive contribution from the fiscal stimulus. We think that these headwinds will continue to weigh on domestic cyclical stocks. Meanwhile, we would maintain a positive stance on corporate credit, reflecting the ongoing private sector de-leveraging, the decline in volatility and the broader search for yield. And, more broadly, we remain of the view that the pro-active stance of policymaking, in the US and overseas (see Monday’s note on China by Yu Song and Helen Qiao), should continue to support moderate returns on risky assets, as cash balances become increasingly expensive to hold, and cyclical volatility declines. Incidentally, we note that even on our new US forecasts, the deceleration to a lower trend should be over as we move into Q4.

 

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Wed, 08/11/2010 - 07:46 | 514811 russki standart
russki standart's picture

Buy Gold, Sell Goldman Short, Bitchez!

Wed, 08/11/2010 - 07:59 | 514821 Sudden Debt
Sudden Debt's picture

overnight Fed announcement... must have been a hard meeting.

here's a overnight announcement of congress that's pretty much the same:

http://www.theonion.com/video/congressmen-submit-emergency-3-am-bill-demanding-i,17473/

Wed, 08/11/2010 - 07:58 | 514822 bonddude
bonddude's picture

Of course buy stocks when rates are zero. Problem is if

you take a bathroom break when you come back

stocks could be 200-300 points lower on S&P 500...

for starters. Flash crash ...

Wed, 08/11/2010 - 07:59 | 514824 Noah Vail
Noah Vail's picture

Yeah, like I'm going to believe anything Goldman has to say? No way. Is this stuff posted as satire or what? Why don't you give us the official White House view while your're at it, LOL

Wed, 08/11/2010 - 08:01 | 514827 bada boom
bada boom's picture

I wish goldman would spare me the BS and instead cut to the chase.

Is this morning's sell off caused by big boys pulling out as people realize the recovery ain't happening?

Or,

Is this just another short trap that will turn postive at the end of the day sponsered by GS and the machines.

I am getting tired of this game.

 

Wed, 08/11/2010 - 08:39 | 514876 mephisto
mephisto's picture

Both.

The selloff started in Japan where they know what pointless central bank tinkering looks like. And if some monkey-coded algos take us higher for the US close, the world will sell it back down again for tomorrows open.

EDIT - I wouldn't sell at the open. The FX market is primed for a USD selloff on the trade figures, algos will interpret that as equity bullish.

Wed, 08/11/2010 - 08:07 | 514835 Jason T
Jason T's picture

5 year at 1% when cost of college tuition rises 5% per year, in 5 years time, you won't be able to go to college.  Out of the budget.

Property taxes going up 5% per year for 5 years, will also set back the middle class to serfdom.

 

This math is like dying a long slow death.  

We need Henry Clay to  rise from the dead and teach Americans about something called "The American System" to save us.

Wed, 08/11/2010 - 08:14 | 514847 Catullus
Catullus's picture

Henry Clay was a major supporter of central banking by supporting the Second Bank of the US.

Wed, 08/11/2010 - 08:23 | 514862 Jason T
Jason T's picture

huh.. I didn't know that.  

 

Henry C. Carey is better rep then.. Henry Clay can stay 6 Ft under.

Wed, 08/11/2010 - 08:36 | 514882 nevadan
nevadan's picture

It is good to see someone knows their history.  Well done Catullus.  I just yesterday finished reading The Real Lincoln by T.J. DiLorenzo.  An excellent book that describes Clay and the Whig position very well.  I highly recommend it.

Wed, 08/11/2010 - 08:08 | 514836 Eduardo
Eduardo's picture

How can they say that any fed action will push investor into risky assets if after a 2 trillion fed balance the inflows in the equity markets are short 1/2 a trillion of their own expectation and even negative regarding retail investors ?

jpm, gs and other need to kicked out of the "markets"

Wed, 08/11/2010 - 08:17 | 514844 Chumly
Chumly's picture

"...and real GDP growth is losing the positive contribution from the fiscal stimulus."

No kidding?!

It's the 2 minute warning and the score is MPD 100 QTM 0

 

"Money Multipliers are collapsing everywhere..." baWAhahahahahahaha, haha, ha...ahem

Wed, 08/11/2010 - 08:26 | 514845 zhandax
zhandax's picture

Policy my ass.  The Fed realizes that the problem it faces is stretching its maturity schedule beyond immediacy when no one without an artificially-created demand (shadow banking, and it's straining thanks to the eurotrash) wants > 5yr US debt.  Since it is the buyer of last resort, it is safe to assume that we are damn closer to last resort than the bond bulls want to contemplate.

Wed, 08/11/2010 - 08:13 | 514848 mephisto
mephisto's picture

It means those desperate for yield (hi Leo) have to diversify - but to be honest they have already bought stocks a while ago. Garzarelli's audience isn't listening any more, and they dont see cyclical volatility declining.

A 30bp change in yields isnt a big impact on a pension fund that needs to make 10% a year. They can see the equity market is essentially flat for months and the economy sucks, it's a risk asset that I'm not sure they want to increase exposure to. The smart move is to diversify globally as much as possible.

So I'm not convinced the net impact on the SPX bid will be noticeable. Meanwhile the technical damage done globally in the past 12 hours is significant. If we get to the end of today without a bounce, then it looks to me like an intermediate term top.

Of course I am talking my book, I am short like a french president and you don't get much shorter than that. 

Lets also see what happens today to Goldman's "please take my shitty position off me" top VIX trade, short Sep at 27.5....

Wed, 08/11/2010 - 08:48 | 514897 Cognitive Dissonance
Cognitive Dissonance's picture

"we remain of the view that the pro-active stance of policymaking, in the US and overseas (see Monday’s note on China by Yu Song and Helen Qiao), should continue to support moderate returns on risky assets, as cash balances become increasingly expensive to hold, and cyclical volatility declines." In other words, buy stocks.

Hell, not just stocks but oil and junk bonds and emerging markets and penny stocks. Hell, they even recommend having unprotected sex with that escort you always pick up Friday night in the Hamptons. That's what they mean when they say "risky assets".

 

Wed, 08/11/2010 - 09:02 | 514922 Downtoolong
Downtoolong's picture

My interpretation of Goldman's advice is always much simpler. They're already long whatever they are recommending you buy and already short whatever they are recommending you sell. Don't be surprised if you follow their advice and they turn out to be your counterparty.

I wonder if it gets boring when all your trading is based on inside information?

 

 

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