When it comes to the future, suddenly torn by economic uncertainty driven by a plunging stock market and a tanking economy, the talking heads and the sellside brigade have opined: more QE, preferably in the form of asset purchases. After all it was none other than Goldman earlier today who said [7]that "our confidence that the FOMC will ease policy once more at the June 19-20 meeting has also grown... Our baseline remains that Fed officials will purchase a mixture of mortgages and long-term Treasuries, financed via balance sheet expansion... If they decide to extend their balance sheet, they could add excess bank reserves or “sterilize” the reserve impact via reverse repos and/or term deposits." In other words: not sterilized, or bye bye Chubby Checker (recall that even Goldman finally admitted two months ago [7]that when it comes to Fed intervention, what matters is flow - as a result Twist has been largely ineffective in recreating the effect of QE1 and 2). To be sure even more respected investors like Pimco have bet the house [8]that the NEW QE will constitute primarily of more MBS purchases. Yet the real question is what is the bond market telling us: after all when it comes to matters such as these, one should completely ignore stocks, and certainly the talking heads, and instead focus on what bonds are saying. And here is where the stock market may be headed for a great disappointment: because now that the bar has been set so far, anything less than full blown LSAP, or a merely extension of Twist, would likely send stocks plunging. Which, ironically, and completely in opposition to stocks, is what bonds are expecting...
Recall that Zero Hedge first presented [9]two months ago the refutation to Hilsenrath's manufactured leak [10]that the Fed could do more QE if need be, in the form of more Twisting. Well "need be", however there is one small problem: the Fed will run out of bonds to sell in the sub-3 Year maturity window: after June 30, the Fed will have only $175 million of sub-3 year TSYs in the SOMA, which means an outright extension of Twist under the existing conditions could last at most another 2 months.
There is however one loophole: merely shifting the selling "detachment" point one year to the right: instead of selling 3 Years and less, the Fed could sell bonds maturing in 2016 and sooner. This would provide the Fed with enough dry selling powder to last it for quite a few months.
This is precisely what bonds are implying will happen, as the below analysis from Barclays.
It also means that the stock market, which is now fully ignroing the possibility of a simpe Twist extension, and demands unsterilizied Balance sheet expansion, will be very, very disappointed if on June 20, Bernanke announces what the bond market is saying right about now.
From Barclays:
Well I've been gone for a while, so I thought I'd just share observations on my return. With the poor report, chances of additional easing have increased. So far it seems the marktet has moved away from pricing in qe through sterilized reverse repos as 1yr OIS is moving virtually in line with overnight fed effective (chart 1).
[11]
This shouldn't happen if you expect reverse repos down the line. Instead, the market is pricing in an op twist extension into the 4yr point. Attached is a chart of the 3 week change in Tsy-OIS through the curve graphed against the remaining SOMA holdings within a 6 month range of each maturity point. As you can see, there has been a huge cheapening in the 4yr point where the Fed would need to move into to continue twist and the other notable mini spike being around the 2/14-4/14 area where the Fed still has large holdings.I'm still not sure what the Fed will do and haven't fully judged the valuations off these moves, but I thought it interesting to point out how the bond market seems to be voting so far in terms of additional easing.
[12]
Translated: when it comes to what is announced on June 20 at 2:15:01 pm (assuming there are no more Federal Reserve Xerox machine snags), bonds are bracing for the worst: which under the current circumstances is the Venn diagram intersection between full blown LSAP-based QE, which would at least send stocks soaring, and no QE at all, which would at least preserve the illusion that a virtuous cycle is still possible if only on paper.
Under these conditions, Chubby Checker would be the most unwelcome visitor for what is left of the equity bulls possible.