We have already discussed what is priced into FX markets [4] with regard QE3 - and as Barclays notes, we also saw a similar gain in momentum into QE1 and QE2 (only to fade post the announcement). Mortgage traders see a sizable QE3 more than priced in, which is especially notable given the consensus forming around the NEW LSAP being centered on the MBS market. Of course, global markets are imbibing more than just the hope of the Fed's extreme policy actions but the ESM ratification as well as handicapping ECB's OMT conditionality (and European growth expectations). Having said all that, it is worthwhile to get a sense of just what happened among the major risk asset classes into and beyond the prior QE (and Twist) announcements, and just what these markets have been doing in the lead-up to this much-anticipated announcement.
The spread between Par MBS and the 10Y CMS has compressed to near-record lows - implying more than a little expectations that the Fed will do its next greast LSAP in the Mortgage space - in size...
[5]
...and across six of the most often cited risk assets,
[6]
as Barclays notes:
Interestingly, the build-up to the FOMC decision has been different this time around, with the S&P 500 and oil prices rallying over the past three months. This partly reflects a degree of anticipation of looser policy in the US. If so, this means that if QE3 does occur, the subsequent rallies are likely to be more muted, in our view.
It seems that no matter where one looks, as one wise old mortgage derivative trader put it "the rumor has been bought."
Charts: Credit Suisse and Barclays