QE3 and its potential unintended consequences on bond yields

Following the Fed’s announcement of (yet) another round of quantitative easing, global stock markets responded with a resounding “yes, thank you” at the end of last week.

The chart below shows the S&P 500 since September 2008 and the yellow areas mark the beginning to end of the prior quantitative easing programs.

Even though two QE cycles are not enough to establish a trend, notice that the stock market rallied during the prior two QE periods and fell sharply when they ended (red arrows). Of course, the S&P 500 was up substantially before these declines and ripe for a correction. More importantly, the index established a higher low after each decline and subsequently advanced to new highs. As the blue channel lines show, the trend is clear on this chart. Even though chartists can debate whether or not the index is overbought and ripe for a correction or pullback, there is no arguing the uptrend.

What was interesting about the Fed’s QE3 announcement was the fact that they decided to purchase mortgage-agency debt rather than adding to their existing Treasury debt holdings. This put downward pressure upon agency debt yields of course, but then it also provided for a rise in both the 10-year note yield as well as the 30-year bond. Our interest lies in rally in the 30-year bond yield, and which we covered in the current edition of our magazine (click here, page 58 – http://issuu.com/spreadbetmagazine/docs/spreadbet-magazine-v8_generic) in suggesting a long term trade simply sitting on the short side in US & UK long bond contracts. A look at the chart below continues to shore up our conviction in this trade.

If we look at the monthly chart of the 30-year bond we can see that the previous support at 2.50% has held; we find the distance below the 115-month moving average tested its -40% oversold level and bounced – and we are starting to see the 14-month stochastic turn higher. This all argues for higher bond yields. But what we find more than a passing interest, is that since QE policy moves have come into being since 2008 – each and every announcement always led to higher yields and a test of the 115-month moving average. If that is the case now, then we’ll see the 30-year bond move from 3.08% upwards of 4.37% in the months ahead.

Anyone who has a variable rate mortgage and finds themselves unable to move mortgages due to the crazy credit constraints currently in place in the UK could in fact look to short Long gilts pro rata to your mortgage size. To me, this facility provides for an interesting way to mitigate this – and tax free.

Ironically, the Fed putting the pedal to the metal on QE3 may actually result in higher bond yields and so rising mortgage rates for embattled US citizens – precisely the last thing they (seem) to want!

Editor

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