War Room 30 May 2013 The End of QE
War Room • Monthly macro discussion • Using tools in context • Update on HiddenLevers Features • Your feedback welcome
The End of QE • QE – History + Analysis • QE – Current Fed Posture • Exodus from Bonds? • IV. Scenarios + Macro Themes
HiddenLevers QE – History + Analysis
Fed Mandate: Room to Run Employment Mandate: Above target 6% region Unemployment still ugly 7.7% Source: HiddenLevers Interest Rates Mandate: Record low rates No problems here Source: HiddenLevers
QE + Interest Rates May 29: 2.13% Rates have fallen at the tail end of previous QE cycles, as fear trade set in – has the cycle broken? source: AdvisorPerspectives.com
QE + Equities Previous QE rounds ended with a market top or significant correction. Either this time is different – or we’re not yet at QE ending. source: AdvisorPerspectives.com
QE + US Dollar QE 1 QE 2 QE 2.5 (Twist) + QE3 Japan QE = stronger USD source: HiddenLevers - QE1 + QE2 drove down USD, as Fed fought deflation- Japan aims to double money supply in next year – USD strong
QE + Housing QE’s downward pressure on mortgage rates (via benchmark 10y) has had a positive impact Will this impact be dampened by the recent spike in rates, or has the housing recovery become self-sustaining? source: HiddenLevers
Stocks versus Bonds – Yield Reversal? Bond yields recently topped equity (S&P 500) yields for the first time in a year – this is the historical norm outside of the Great Depression and Great Recession.
It ain’t over til its over HiddenLevers QE – Current Fed Posture
Fed May Minutes: The Skinny Fed Speak Translation …continue purchasing additional agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month. QE ain’t over til its over FED MINUTES …as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee's 2 percent longer-run goal… No rate hikes anytime soon Vote on maintaining actions – 11-1 2-3 votes against = revolt
Exiting QE: choices for the Fed stop recycling matured assets into purchases taper down $85b in monthly purchasing 2y 10y purchase only shorter end maturities hike discount rate
Timing of Exit – When will QE End? Official Fed line, based on 6.5% unemployment achieved 2015 2016 Big bond dealers + Goldman Sachs chief economist John Hatzius “Assumption that Fed balance sheet will be normalized by 2025” -Janet Yellen, likely Bernanke replacement 2025 Akin to drugs, withdrawal from QE will not be without pain.
HiddenLevers Exodus from Bonds?
Bond Exodus: The Great Rotation? Great Rotation Investors confident in economy leave safety of bonds, shedding residual fear of financial crisis great rotation sitting it out in bonds playing the field with equities
Bond Exodus: The Great Rotation? No Great Rotation This is NOT happening. Money Market funds cash is flowing into both bonds and equities. + take a chance in equities play what works in bonds
Bond Exodus: The Great Rotation? Bond Exodus = overblown Money Market Funds, yielding zilch, give way to bond inflows. Bottom Line Cash for Equities is NOT coming at expense of bonds Bond Fund inflows Equity Fund inflows $14 billion Jan/Feb 2012 $68 billion $64 billion $76 billion Jan/Feb 2013
Bond Exodus: Redux of 1994 Massacre? 8.0% 50% rise 5.25% - $1.5 Trillion global bond market losses - yields spiked 275 basis points in 6 months - long term treasuries lost over 10% in 1994 - current lower rates = losses would be greater
What about Stock Exodus? 1965: S&P -12.2% 1972: S&P 4.8% 1987: S&P -6.2% What happens to stocks after the Fed begins to tighten policy? Average 1Y S&P Return post-tightening: 1.5% 1994: S&P -4.6%
HiddenLevers Scenarios + Macro Themes
End of QE: Baseline Scenarios • Good • Economy • back on track • Bad • Stagflation • Ugly • Deflation strikes back S&P up 6% since March scenario intro Fed made clear that QE-Infinity preferable to Deflation BOJ: doubling Yen money supply to fight deflation 10Y treasury yields up 70bp from 2012 lows
New QE Scenarios: Bond Exodus + QE-Infinity Fed continues QE for years to stoke GDP and employment Melt-up scenario with irrational spike to upside Only possible if inflation stays down, freeing Fed’s hand on QE source: HiddenLevers Bond market traders try to front run Fed tightening Patterned on 1994 bond crash – equities were volatile but stable that year Speed of rate move could surprise investors if this scenario unfolds
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