The Fed’s QE2 plan to buy $600 billion of Treasury bonds over the next seven months is intended to drive long-term interest rates lower in an effort to lower borrowing costs, including mortgage rates. The program began last week.
But uh-oh. It isn’t working. ‘Bond king’ Bill Gross of PIMCO, the world’s largest and arguably most successful bond fund manager, had warned that the Fed’s plan could have the opposite result, driving bond yields higher (bond prices lower) and ending the 30-year bull market in bonds.
And indeed, bond yields have been rising (bond prices falling) since the Fed first began talking in early September of providing the stimulus. Our technical indicators caught the reversal, the apparent intention of bonds not to cooperate, and our downside position in an ‘inverse’ etf on bonds is paying off.
The 20-year bond has fallen 11.5% in the three months since early September. Even the 30-year bond has declined 7.5%. Both have now broken below the potential support at their 30-week moving averages.
The rise in borrowing costs could have a negative effect on the economy rather than the positive stimulus effect the Fed anticipated.
It was also expected that QE2, with the Fed printing tons of dollars to finance its big bond purchases, would result in the dollar extending its decline against global currencies. That was expected to be another positive for the U.S. economy, making U.S. exports to other countries less expensive and prices of imports from other countries more expensive.
And indeed, the initial reaction to the Fed’s announcement a couple of weeks ago was an immediate resumption of the dollar’s decline, the dollar reaching a new low.
However, the downside reaction so far has been short-lived, at least short-term, with the dollar having rallied back 2.8% off that low, and breaking out above its 30-day m.a., to its highest level since September.
Will its rally also morph into an intermediate-term move, as has happened with treasury bonds?
So we have bonds and the dollar defying the Fed’s QE2 intentions, neither moving in the direction the Fed intended to provide additional stimulus for the economy.
The saving grace may be that recent economic reports indicate the economic recovery is back on track on its own and may not need more stimulus.
However, gold and global stock markets have also reversed from their initial reactions to the Fed's decision. It it a belated case of buy the rumor and sell the fact, or an indication that QE2 is going to cause more problems for the economy than it solves?
