The QEnundrum

The US Treasury Department announced yesterday that it has completed an auction of 20-year bonds. Quite unlike the one 7s auction – you know, that one – this particular bond sale was positively uninteresting. Like all the rest of the bills, notes, and bonds since February 25, there an overwhelming number of bank dealers and other participants some of whom seem hellbent on paying any price for the paper.

The low accepted yield today, which represents 5% of all bids, was practically zero, just 8 bps. Demand for long bonds yielding barely more than 2% continues to be thorough even as, discussed yesterday, US central government debt levels skyrocket and show absolutely no sign of slowing down though the gross economy has for more than a decade.

How can this be?

Some say that it is the Fed which is artificially inflating demand for Treasuries (and other asset classes) due to its own bond buying programs. This latest LSAP, or large scale asset purchase, otherwise known as QE6, has seen the central bank’s SOMA holdings of notes and bonds (though, curiously, very few bills) explode upward by $2.5 trillion since last March.

Yet, even the central bankers know this isn’t the reason for stubbornly low yields on these securities. As I’ve endeavored to point out as often as I possibly can, the academic literature, most of which has been sponsored and written by central bank staffs, is conclusive. I still love the way the Reserve Bank of New Zealand just comes right out with it:

Studies found the government bond purchases worth 10 percent of GDP have, on average, lowered 10-year government bond yields by around 50 basis points.

Underwhelming, isn’t it? Pitiful, actuallyl.

The Federal Reserve’s purchases over the last thirteen months are only a bit larger than 10% of GDP, thus, best case, bond yields are just 50 bps lower than perhaps where they otherwise would have been – if you take this average view at face value. Arguably, and there’s much data to support significantly less than this, the reason why most of these papers use “term premiums” as a standard for measuring QE impacts, the effect on yields is negligible.

Even if we account for somewhere between zero and 50 or so bps, that still means US Treasury rates are ridiculously low otherwise; demand easily sustained (as the auctions results demonstrate, one after another with the single exception).

What is this demand?

As usual, we’ll leave it for Richard Fisher (of all ex-FOMC officials) to explain:

MR. FISHER. In summary, I want to mention that, as I said earlier, most of these variations that have been suggested are very un-Bagehot-like. And what I mean by that is, twisting [or QE and yield caps] entails purchasing assets that investors are fleeing toward, not assets that they are fleeing from. [emphasis added]

This is why the studies show only limited effects directly on yields – because the market has reduced them far, far more than QE ever would, will, or can by itself. The questions, therefore, are who and for what purpose(s) are doing the “fleeing toward.”

Rather than being a possibly neutral proposition, here we begin to see and appreciate its rather insidious downside. What I mean is, even if the bank reserves that QE creates as the accounting leftover of what is nothing more than an asset swap doesn’t really help (and it doesn’t), that doesn’t necessarily mean it can’t hurt to try anyway. It absolutely can hurt, and more recent investigations are starting to clue in on this as-yet unacknowledged aspect.

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Disclosure: This material has been distributed for informational purposes only. It is the opinion of the author and should not be considered as investment advice or a recommendation of any ...

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