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6/13/2011

Does the whole QE stimulus initiative make any sense?

Over the past few weeks the marketplace has come to expect an end to the QE2 stimulative initiative given no announcements of a QE3 in the pipeline.  Markets have adjusted accordingly as the major Stock indexes have retreated noticeably, but does the  adjustment in the Fixed Income sector make any sense?

Remember, QE2 included Treasury purchases by the Federal Reserve in order to keep interest rates low in the medium and longer end of the Treasury curve.  Some of the logic was to provide support to the beleaguered real estate market and increase overall lending in the business sector.  Reality was however that yields on longer dated Treasuries increased somewhat over the time QE2 was set in motion….a move that surprised some of the most sophisticated investors.  Now that QE2 is expected to end, one would think that Treasury prices should decline to some degree given the lack of purchases by the Fed…but guess what…just the opposite has been transpiring.

Now one explanation is that investors are expecting an economic slowdown because of an end to QE and therefore a drop in interest rates, but if this were the case, why would the Fed need to aggressively purchase Treasuries during QE to keep rates low in the first place given that the economy was sputtering?  The whole scenario doesn’t smell right.

Could it possibly be that the Fed wants to end QE2 to spur a rally in the Treasury market to push rates lower and help stop the bleeding in real estate market?  Wait a minute, that’s what QE was supposed to do, but it didn’t work.  Stop the madness.  The bottom line remains that the US economy is plagued with significant structural imbalances with the main root to the problem being high unemployment.  Is a slow down coming?  The answer is, it was always here.