Thursday, December 16, 2010

Is the Fed's QE2 Leading Bond Prices Down?

Mike made an interesting comment to his previous post on the Fed's implementation of QE2 that may detail the trading relationships between the Fed's bond purchases in QE2 and trading in the bond markets:

The Fed is buying "scale down" and in effect, causing the selloff. They're doing this because they're fixated on quantity ($600 bln) as opposed to price (interest rate). I remember when I was a floor trader. I had clients in the oil business--big firms--who would sometimes want to protect a certain price. They'd give me an order that would be, "Buy 100 (crude), 'worst.'" That meant buy it up...aggressively. When Japan used to actively intervene in FX markets, they wouldn't scale down their dollar buying (or sell yen scale up), they'd buy dollars aggressively to put the USD/JPY exchange rate to a certain level. The Fed is not doing this. By signaling to the market that they will buy scale down, they are actually creating this selloff as nervous longs look to sell before the largest buyer lowers its bid again and as speculative shorts compete for a better price.
If this is not an accurate depiction of the Fed's operations here in QE2 since November 12th, I would request that they then detail what the heck they are really doing. How are they arriving at the price at which to buy the bonds? These would be some good questions for Rep. Ron Paul to ask if he ever gets his "audit the Fed" train rolling. I hope Rep. Paul has the sense to call Mike before any hearings!

15 comments:

Tom Hickey said...

Matt, the Fed surely knows that they can buy all the bonds they want at the cost of a few keystrokes to support any price/yield they want.

Are they just getting out of the way on this move? It is possible that the goal is freeing up funds for riskier assets, like equities, for the wealth effect.

Some of that money will also flow abroad, driving down the dollar and improving the export position.

It raises the ceiling on mortgage rates, but no one is buying houses anyway.

Matt Franko said...

Tom,

I see your point, it would be hard to believe that they would do the first month of QE2 so clumsily as Mike points out but I think they may have exacerbated the fall ... ie they couldnt have gotten completely out of the way because the have been buying all the way down (over 100B+ in the month) I mean if they didnt buy any and just let the market fall and waited till the move was over then yes......I dont understand exactly what Mike means by "buying on a scale down" that is a commodity term Im going to look into Ive heard it before... I assume this means putting in sequential large buy orders at ever lower offer prices. This sounds like it could drive prices down in the short term...

I will say to your point about "this move" that everyone on the Media channels is bearish on bonds due to "printing money" All message boards, CNBC guests, blogs, etc are all looking like they have been selling the bonds due to this misperception of money printing, etc... maybe the 10-year can find support here at 3.5% if these people are all in now.... and the Feds buying can take over and support higher bond prices...

Tom, I dont trust them one bit. I honestly think you know more about these operations than they do at this moment. You would make a better Chairman than BB right now...

Resp,

welfarewarfare state said...

Matt,

I think that bond yields are going up because bond vigilantes know that the Fed has already shot their wad. They can't keep interest rates low simply by buying debt forever. They will destroy the currency if they keep going back to that well. We may get to the point where the only entity willing to buy our debt is the Federal Reserve. Rates have to rise to reflect the default risk that the U.S. poses. Paying back our creditors in a debased currency is a de facto default. We should be honest and work out a payment schedule with our creditors that allows us to pay back 50 to 60 cents on the dollar.

Tom,

Some of that money will go abroad resulting in lower export prices, but at what cost? Currency devaluation wars only result in us shooting our own troops in the end. Our primary export at this point seems to be monetary inflation. Just ask China.

Tom Hickey said...

Welfare, the result of China's peg is that the ROW, especially the US, is exporting inflation to China and China is exporting deflation to the ROW.

BTW, I would agree with Jeffrey Gundlach (link) that this is blip and doesn't indicate a reversal in bonds.

TomatoBasil said...
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Mario said...

what if the Fed was taking the other side of long positions in bonds...so that all the bulls of the past year had someone to take the their trade so they can more easily and swiftly exit and profit????

what if that's what the buying bonds was all about?? And the Fed chose to maybe "bite that $600 bill" figuring it would be worth it in the end b/c rising yields are actually good for the market as it indicates rises in inflation (which the Fed also wants) and therefore stock prices tend to rise (which the Fed I think also wants), so everything is good (at least on the surface)...also with higher yields that MIGHT bring back more bond investors interested in higher yields to help with the budget for next year (maybe a more minimal point but none-the-less I don't think a rise in yields is a "bad thing" at all. Also Airelon has aptly pointed out that they very well may be going for getting the BOND CURVE where they want it more than a particular interest rate as you suggest here.

Mario said...

typo...for clarity's sake, I meant to say:

"so that all the bulls of the past year had someone to take the OTHER SIDE OF their trade so they can more easily and swiftly exit and profit????"

welfarewarfare state said...

Tom,

Which is why China will eventually depeg from the dollar completely and let the yuan rise. I read a news piece yesterday that reported China's price inflation rate was over 10% last year. This has already caused flare ups of social unrest.

Mario said...

honestly...who knows wtf china will do...ever...period. can I get an amen!?!? haha!! dude they could honestly do ANYTHING at any time imo...china is so unpredictable and seems to view their own best interest in ways I can't comprehend way too much. I've given up on china and trying to forecast them. IMHO...let them do whatever they're gonna do...it's all a whatever to me...it's almost as if China (as a nation/country/power) is more interested in POWER over its people rather than prosperity for its people...it's all about CONTROL with China...nothing more IMHO and frankly, I think that is exactly what will at best keep them stagnant or out of balance in their growth patterns.

Mike Norman said...

What's even more amazing is how the Fed came up with its $600 bln bond buy figure. If you recall, the Fed surveyed market participants prior to making their decision on QE2 and the respondents came back with a number of $500 bln. So what did the Fed do? It simply added another $100 bln for...shock and awe??

This is truly astonishing. This is like Walmart going to its suppliers and asking them how much they (Walmart) should buy and what price it should charge. At least Walmart has the sense not to do this. It dictates the terms, regarding both quantity and price!

What's worse is that the Fed is a monopolist, with TOTAL control over interest rates and the quantity of reserves it can create. Yet, it went to market participants to ask what to do.

ANY monopolist in the commercial realm would understand that IT ALONE DICTATES PRICE AND QUANTITY!

The idiots at the Fed don't get it!!!

Matt Franko said...

From the Investor Dictionary:

"Scale-down buying tends to match up with scale-up selling, which is buying low and trying to pick a bottom but diversifying the position in time. The lower the price goes, the more you want to buy. For instance, if a trader bought all the way down to $12 for a barrel of oil in 1998 and then sold as the market rallied and kept on selling to $39, one would believe he or she would be rich. However, all of the margin calls to deposit more money into his or her brokerage account would put a different spin on the profit picture. Producers of oil-related products such as gasoline or airlines tend to be scale-down buyers of jet fuel in order to lower their average cost of fuel. With their large credit line they can cope with the margin calls. This term is typically used in the futures market."

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MortgageAngel said...
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beowulf said...

One problem is that Fed officials are sharing nonpublic, market-moving info with select traders. It destroys any chance the Fed could shock and awe the market.
http://www.reuters.com/article/idUSTRE68S01020100930

So is there common ground with Ron Paul, say if he sponsored a bill to close the FRB and bring monetary policy under the Secretary of Treasury (in some form or fashion, I can't imagine not keeping the regional Fed banks around)? I think hes written than a Tsy-baed fiat system is a step forward from the current situation.

Speaking of buying on a scale down, right after Pearl Harbor, Tsy and the Fed agreed to run a market tap. The Fed bought as many Treasuries as it took to cap the short term rate to 0.375% and the long-term rate to 2.5%. That deal ran (with only minor adjustments) lasted until 1951. The Fed could unilaterally decide to do that tomorrow. I suppose an Act of Congress wouldn't hurt, I'm not conting on either. :o)

Matt Franko said...

Beo,

I'm sure some of the larger bond dealer banks are able to front run because of this to an extent ... I look at this as 'baksheesh' .... that regulators turn a blind eye to this as a form of 'compensation' to the industry.

Resp,