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Wednesday November 3, 2010 - 21:06:42 GMT
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QE2 Post Mortem (FXA)

QE2 Post Mortem


I feel like one of the Texas Rangers facing Tim Lincecum with a 3-2 count…you know a fast ball is coming…that did not make hitting it any easier. The FOMC with Bernanke on the mound delivered nearly exactly what the markets had anticipated and very deliberately.  It wants asset prices up (risk), low Treasury yields and the dollar down…these are the only variables that it knows QE can impact.  It does not know and probably does not have a lot of confidence in whether these translate into any greater real economic activity.  But the Fed gets paid for doing something, is mandated to do something and doing nothing is not an option despite the message from the election and all those free market, Austrian economics loving citizens who voted Tuesday. 


So the Fed promised to buy another $600bln through the end of Q2 2011, or about $75bln a month however the Fed will also buy an additional $250-300mln with proceeds from existing assets that mature (or in the case of some of MBS are prepaid due to refinancing or loan payoffs) making the total purchases a month around $110bln for a total of around $850-900bln.  So it is a little less than the $100bln a month the market expected not including the reinvestment program or I line with expectations if it is included.  I would not describe the net new purchases as QE2-lite.  There is nothing lightweight about this program in scale or pace.  The Fed also said it could adjust the program based on the evolution of the economy and presumably market conditions. 


The NY Fed outlined how the program will be executed (below) and as expected it anticipates it will buy gvt securities with an average maturity of between 5 and 6 years – nothing under 18-months and only 4% in the 17-30-yr range.  The bond market sold off on the light touch the 30-yr received but I think this had to have been pretty clearly signaled to the Treasury borrowing committee and Hilsenrath in the WSJ.  So I find this a little curious. 


In terms of market reaction there was a sell-the-news (risk) on the announcement initially but it did not last long as many look to reload on any weakness (for the dollar it is strength…reload on shorts).  Again this is one of those rare moments in financial markets when the normal skepticism about how markets trade should be thrown out the window…record USD short exposure is embraced by the Fed via its actions, blessed by US Treasury in its silence and there for the taking….contrarians be damned.  I think the same approach applies to stocks from the long side until we see the next level of the currency war breakout around G20 summit in Seoul November 11-12…capital controls and sanctions are coming and this will be a huge potential negative for global growth and equities.  The USD traded through the October low versus the EUR (1.4157) on the first headlines on the FOMC only to trade back up and then again down…looks like it is set to close around the October low.  This should see 1.45 by Friday if US jobs are weak.  If US jobs are strong sell the USD rally.  Yes it is that simple.  Make no mistake the printing of money by the Fed to speed up US growth is more than an invitation to sell dollars for risk currencies…it is a command.  And if you think it will be pushing on a string for the real sector as I suspect, and US fiscal policy options are ever more closed after the US election, then this program is only in its infancy…it will not end in June 2011. 


David Gilmore  


 FOMC directed the Open Market Trading Desk (the

Desk) at the Federal Reserve Bank of New York to purchase an

additional $600 billion of longer-term Treasury securities by

the end of the second quarter of 2011.


Based on current estimates, the Desk expects to reinvest $250 to $300

billion over the same period, though the realized amount of

reinvestment will depend on the evolution of actual principal



Taken together, the Desk anticipates conducting $850 to $900

billion of purchases of longer-term Treasury securities through

the end of the second quarter. This would result in an average

purchase pace of roughly $110 billion per month, representing

about $75 billion per month associated with additional

purchases and roughly $35 billion per month associated with

reinvestment purchases.


The Desk plans to distribute these purchases across the

following eight maturity sectors based on the approximate

weights below: Nominal Coupon Securities by Maturity Range*

5 pct:  1-1/2 - 2-1/2 Years    

20 pct: 2-1/2 - 4 Years

20 pct: 4 - 5-1/2 Years

23 pct: 5-1/2 - 7 Years

23 pct: 7 - 10 Years

2 pct:  10 - 17 Years

4 pct:  17 - 30 Years

3 pct:  TIPS


Under this distribution, the Desk anticipates that the assets

purchased will have an average duration of between 5 and 6

years. The distribution of purchases could change if market

conditions warrant, but such changes would be designed to not

significantly alter the average duration of the assets



To provide operational flexibility and to ensure that it is

able to purchase the most attractive securities on a

relative-value basis, the Desk is temporarily relaxing the 35

percent per-issue limit on SOMA holdings under which it has

been operating. However, SOMA holdings of an individual

security will be allowed to rise above the 35 percent threshold

only in modest increments.


The Desk expects to conduct the November 4 and November 8

purchase operations that were announced on October 13, and it

plans to publish its first consolidated monthly schedule on

November 10 at 2:00 p.m.




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