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Quantitative Easing, or QE, is a term that many investors were forced to understand. Then came QE2 as an even more difficult pill to swallow. After the FOMC or any central bank has taken rates to zero, there is really nothing left to do other than implementing different unorthodox easing measures outside of lowering interest rates. QE2′s formal end occurs this week as June comes to an end. Finally! The great worry is that now the gloves will be off and the biggest buyer in the bond market will be gone. In short, now rates can finally rise as they would have without the government buying the extra billions and billions of dollars in Treasury notes each month.
But…. The worries may be wrong. The end of QE2 may already be reflected in the stock market and bond market.
It is hard to imagine that the markets can adequately price in any major event of this magnitude after what we have witnessed over recent years. This time may be different. If you think about it, it is not too unreasonable to think that the entire end of QE2 is already priced in. 24/7 Wall St. has come up with ten less-considered issues that point to the end of QE2 already being priced into the markets.
1. Bond Buying Competition
Many bond buyers have looked elsewhere for returns. If the government is buying up Treasuries and driving down yields then the idea is that there is a larger buyer than any other market participant. Now that Uncle Sam is going to be only reinvesting maturing assets, the ‘normal bond buyers’ (and sellers) will have a true bond market that moves without the impact of billions of dollars being purchased in Treasuries each day by the government.
Bonds also have commodities and stocks as competition. While stocks have started to recover from a large selling wave since the end of April, there was a drop in stock prices for six consecutive weeks. Commodity prices have also backed off of their highs. Gold has come off almost $100 an ounce from the highs. The Dow Jones Industrial Average fell almost 1,000 points in the last two months before the fresh recovery attempt. In the last three-months, the 10-Year Treasury yield fell from 3.50% to under 2.90% before the latest move back up to 3.04%. The world markets cannot only be full of investors who run for the hills via the safety of Treasuries.
In short, if the bond market was going to unravel in one massive swing then the yield on the 10-Year Treasury would have risen in anticipation of this event. Most investors fail to consider that the government’s peak Treasury buying was actually months ago. The government’s Treasury buying has been far less buying competition as a result.
2. Banks & Higher Reserves
Banks will be buying more Treasury notes in the months and years ahead. The new regulations that are coming for the “too big to fail” banks all point to higher capital requirements even than what had been imposed after the TARP saved these banks. That translates to less lending and putting cash in risk-free assets as reserve capital. That means more bond buying by the major banks. Those deadlines may not come until 2012 or 2013, but this matters as it means billions and billions of dollars each month will keep rolling into short-term and intermediate-term Treasury bills and notes. BofA, J.P. Morgan Chase, Wells Fargo, Citi, and others all just lost their ability to invest in riskier assets and to make riskier loans.
The Basel Committee on Banking Supervision has even noted that this could effectively double or triple the core reserve requirements. The aim is to protect the banks from ever becoming insolvent. Less lending will result, which means less risk-capital in the system and possibly a slower economy as a result. That will keep bond yields relatively low.
3. Greece, and other rotten PIIGS
Greece may be on the verge of another round austerity measures, but go find one market participant who believes that this will truly be the end of Greece’s woes. Greece has a history longer than can be counted easily of not being fiscally responsible. An agreement to be responsible today does not mean that the politicians of tomorrow will comply.
Greece is just one of the PIIGS. Ireland, Portugal and Spain are all close to facing the debt firing squad as well. The ratings agencies have all been very negative on these nations and they are all far from being out of the woods. The Swiss market is not large enough to be the true safe-haven, so investors have been and will continue to be forced into buying short-term and intermediate-term Treasuries as their money has to find a safe haven. This could be going on for months or it could go on for years.
4. China & India
China and India have both been slowing their economies. China was fighting an overheating and inflation scenario, while India has been doing its best to fight off the inflation beast. If they are not going to foster global growth, does that translate to a runaway yield curve?
China may desire to invest its endless billions of dollars elsewhere, but in the end it almost has no choice but to be a bond buyer. After Uncle Sam is out of the business of making an artificial market the Chinese may return as Treasury buyers. China would prefer to buy real assets, but they have so much capital available that the commodity markets and other bond markets just do not compare in size to our own bond market in the United States. By default, there may just be no other place to go put money to work.
5. Commodity Prices & Inflation
Ben Bernanke is currently looking as though the “transitory” rise of commodity prices and inflation may have been correct. Oil has fallen $15 a barrel, gold has fallen almost $100 an ounce, and that runaway silver market has all but gone quiet. Food prices are now substantially off of their wholesale highs that had been seen in wheat, corn, and other commodities. Now that the CFTC has figured out that raising margin requirements can keep the speculators more at bay, that has taken the breath out of commodities. Inflation is generally driven by higher input costs. If oil, gold, and base metals are going to remain less high than before, then the key driver of inflation is becoming less of a threat.
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