Home > Main > QE II: The Fed’s “Cash for Clunkers” Program – and why the End of QEII means “The Godzilla of all Bond Rallies”

QE II: The Fed’s “Cash for Clunkers” Program – and why the End of QEII means “The Godzilla of all Bond Rallies”

March 11, 2011

Remember the “Cash for Clunkers”?  The U.S. Government gave people money for their old cars and helped to temporarily boost  auto sales.  The criticism of this was that it wouldn’t boost auto sales in the long run – all it did was move future sales into the current period.

I am starting to think that QEII does the same thing with Treasury debt. It pushes potential sales of Treasuries forward into the actual period of QEII.

If you were looking to sell $50bn of Treasury bonds in August, wouldn’t you at least consider moving the sale forward a few months, and selling those bonds in May or June?  Who wants to sell during one of the all time great bond selloffs?

The U.S. Federal Reserve has stated they would buy truckloads of bonds during QE II.  So you know you can go into the market and sell, sell, sell – without any real impact on market prices.

And if you’re considering selling Treasuries in May, why not sell them today?  QEII might be suspended…and who wants to sell during one of the all time great bond selloffs? Why not sell them before that happens?

I think that every asset allocator in the world who is even considering selling Treasuries this year will do it earlier rather than during one of the great all time bond sell offs.

It’s cash for clunkers argument applied to Treasuries.  It turns out that the critics of Cash for clunkers were correct – car sales did slow after CfC ended.   Basically, it pulled a bunch of car sales out of the future and into the time frame of the Cash for clunkers program.

The Fed’s QEII is a great opportunity for weakly committed holders of Treasuries to exit their positions.  There is a known huge buyer of Treasuries in the market – why not sell to that known huge buyer?

I suspect this same thinking has something to do with the huge rally that happened at the end of QE I as well.  If you recall, there was nearly universal bearishness for the post-QE I bond market, but the day it stopped, bonds went on a historic rally.  All of the sellers had already sold when they knew the Fed would be there – so only natural buyers were left in the market.

Bond Yields aren’t an exact science.  The Yield Curve reflects the future path of short term interest rates – which is a huge problem for the Fed.  So anything done by the Fed won’t have much impact – and even worses,  is likely to be counter productive given the current dominant paradigm about how money is created.

The mother of all Bond Rallies at the end of QE II

If you look at the dynamic of QE I, you’ll find that during the actual QE, bonds got crushed.   When QE ended, bonds rallied because there were no more sellers.  The post QE I rally was substantial, and Treasuries continued until Bill Gross started selling bonds in his funds due to discussions of QE II.

QE II is discussed, and Bill Gross decides to get out of Treasuries, Treasuries fall.  But curiously, Yields have not been able to make new highs yet.   These weak holders exiting positions are not able to shove yields higher.    So far it looks like inflation expectations are anchored quite well, and that the future path of rates has not been impacted that much.

Now, consider the  post I just had about the radical ineffectiveness of Japan’s QE?  Japan was mired in deflation for most of their QE – and only peaked their head into moderate inflation during one of the great energy spikes of the last 100 years.

All of the weak holders of Treasuries will get out while the Fed is buying.  When the fed is done buying, there will not be any sellers left for the first few months at least.  This of course gives a boost to the bonds for a few months.

And then it starts to become really obvious that QE I didn’t cause inflation, and QE II isn’t causing inflation, because QE doesn’t cause inflation.  So expectations of future rates shift downwards, adding a boost to the bond rally.

Godzilla awakens.  Welcome to 2% long bond yields in June next year.

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  1. Peter D
    March 11, 2011 at 8:36 pm

    “Welcome to 2% long bond yields in June next year.”

    On the one hand, this may sound good – I could probably refinance my mortgage 🙂
    On the other, it would mean basically 0 inflation and maybe even deflation – which would probably mean we’re turning into the next Japan, as Mosler likes to say…

    • TC
      March 11, 2011 at 9:29 pm

      Yes, this is just thinking out loud – more of a potential scenario than a prediction. you know “Strong opinion, held weakly” and all that. I like to use provocative post titles. 🙂

      But, this could happen if we have a fall off in real economic activity. Every day oil stays above $90 a barrel is a bad day. I am seeing Warren’s point about banning speculation in the energy markets. Also, we need to consider government spending will be falling sharply over the next few months, so corporate profits will be peaking sometime q3 of 2011. I don’t have a good feel for what might happen later this year – I have a few scenarios. Housing is really taking a beating, we are starting to see the beginning of the 20% fall I was talking about late last year. All of this together leans to deflation pressures.

      On the other hand, tax reciepts are up huge, so maybe there is a bunch of hiring that we do not see in the official numbers yet.

      I don’t know if you’ve been following coal, but banks are getting into writing swaps on coal. It went from a market where contracts were negotiated once a year to where there are continiously traded, and the price has gone up 10X.

      This increase in transparency isn’t good for our costs…

  2. Peter D
    March 11, 2011 at 8:38 pm

    Or it could mean we are finally filling up the slack in capacity, too. Unless the Repugs nip our recovery in the bud.

    • TC
      March 11, 2011 at 9:29 pm

      Grant me austerity, but not today!

  3. Sergei
    March 31, 2011 at 5:12 pm

    Interesting idea!

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