QE2, Bonds and The Fed’s Real Plan

Share

For those of you that have been following this blog, you’ll recall a couple of weeks ago I suggested that QE2 would either cause rates to go down or cause them to go up, so in either case, you would want to start your refinance so that you were in line to lock in a low rate.  The storm that has ensued since the Fed’s announcement that they would spend $600B to buy treasuries, makes one wonder what the Fed could be thinking.

The Federal Reserve’s stated goal with QE2 (Quantitative Easing Round 2), was to hold rates down, spur lending and borrowing in an effort ultimately, to jump-start hiring.  Contrary to this design it would appear, the negative market reaction is driving rates up, not down.  Fears of a printing press running day and night in Washington, making dollars cheaper, have flamed the fears of inflation, and thus a controversy is born.

Though not a conspiracy theorist by nature, isn’t it possible that Fed Chairman Bernanke actually anticipated this response?  Consider this: Bond yields rise when the demand is lowered, thus the price has to get cheaper to sell.  This then causes the return on that investment, or yield, to rise.  Said another way, if a bond costs $100 and returns 5%, if no one buys it, it has to be discounted to sell (just like clothing).  For this example, let’s say that magic discounted price is $90.  This means that same 5% return equates to a 5.55% yield at a $90 sales price for the bond.  Yield moves in the opposite direction of price.  Price (demand) goes up, yield goes down; price goes down, yield goes up.

I think it is safe to say, that Ben Bernanke has proven himself to be a shrewd businessman.  His investments of taxpayer monies in General Motors, AIG and the like, have proven to be very, very profitable.  With GM now IPO priced at $32 a share, the tax payer should reap quite a return on their investment. So Bernanke understands that if he is going to cause the Federal Government to invest in bonds, he becomes the largest buyer of U.S. Treasuries.  And what do we know about bonds?  When demand increases, they get more expensive and the yield goes down, so rates drop.  But to do this, the Fed has to pay a premium, because they are not the only buyers of treasuries and thus if rates are to go down, price has to go up.  But isn’t it possible that Bernanke recognizes this and has caused a bond sell off just so he can jump in and buy them at a discount?  If the fed is going to buy $600B in U.S. Bonds, rates are going to go down, that would seem to me to be inevitable, so why not buy them at a discount?  It’s a mind bending concept, but I wouldn’t put such thinking past the Fed.  After all, past Fed Chairman Alan Greenspan dominated the financial world through suggestion and innuendo; moving markets without actually doing anything but hint, suggest and infer.  Perhaps not so unlike his predecessor, this Fed Chief is doing the same, only this time it’s with his eye on profits for the taxpayer.

Leave a Reply

Your email address will not be published. Required fields are marked *