So $400 Billion of QE Buys 17 Basis Points of Rate Reduction?

A key paragraph in a post on a new paper by Jim Hamilton:

We can summarize the implications of that forecast in terms of the following scenario. Suppose that the Federal Reserve were to sell off all its Treasury securities of less than one-year maturity, and use the proceeds to buy up all the longer term Treasury debt it could. For example, in December of 2006, this would have required selling off about $400 B in bills and notes or bonds with less than one year remaining, with which the Fed could have effectively retired all Treasury debt beyond 10 years. The figure below summarizes the implied average change in forecast for the 1990-2007 period as a result of this change for interest rates of various maturities. Yields on maturities longer than 2-1/2 years would fall, with those at the long end decreasing by up to 17 basis points. Yields on the shortest maturities would increase by almost as much. While our estimates imply that the Fed could make a modest change in the slope of the yield curve, it would not make any difference for the average level of interest rates.

Note Hamilton clearly states that the Fed could clearly lower rates further. As Scott Fulwiler commented via e-mail:

They just have to announce the rate they want and be willing to buy everything offered at that price. Since the real point of QE2 is to cut longer-term rates, the only conclusion is that they don’t understand the fundamental fact that their operations are about price, not quantity.

Also, Hamilton’s evidence should work in reverse–i.e., don’t fear the Chinese dumping all their lt Treasuries . . . 17bp for every $400B.

I’d love to see a study that parses out the impact of Fed announcements. It might be that talk really is cheaper than action.

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  1. M

    Yves, Michael Pento recently suggested the Fed could start actively buying stocks as part of the new round of QE..
    something the BoJ toyed with (but as I recall backed down from doing).

    Pento comments here:

    BoJ mulling stock purchases here:

    and here:

    QE on bonds was bad enough – but is the Fed now going to (openly) start buying stocks too?

    Given today’s ramp at the close.. I don’t doubt they are doing something now.. but this would be unreal.

    Any thoughts? Please tell me it will never happen!


    1. Yves Smith Post author

      The BoJ has very different reasons for wanting to goose stocks that don’t apply to the US. Japanese banks are permitted to count 50% of the market value of their cross holdings (which admittedly are lower than they used to be) as capital under international agreements. So when the Nikkei falls far enough, the banks start looking to be in trouble.

      The Fed is not permitted to buy equities save under its “unusual and exigent circumstances” clause. The people I’ve spoken to think the Fed would buy equities only in a crash, not as part of QE. Moreover, the equity markets were very much a Greenspan obsession, not share in the Fed at the board or staff level

  2. Diogenes

    Not only should we not “fear” the Chinese dumping their Treasuries, we would be well advised to acknowledge that they *may* already be doing just that (and probably at an unexpected but welcome profit) amidst the current ongoing rally in Treasury bonds:

    “China is the largest foreign holder of U.S. treasury securities, keeping a reserve of $843.7 billion as of June 2010, according to the U.S. Department of The Treasury. The holdings had decreased from $900.2 billion in April to $867.7 in May. SAFE [State Administration of Foreign Exchange] isn’t the only Chinese investor in U.S. treasury securities, and some remain skeptical if China is investing less in the U.S.”


    The more interesting question for me (as a buyer of sovereign US and foreign bonds) is whether, as Jim Hamilton posits, “the Federal Reserve wouldn’t want to buy up the
    entire stock of outstanding public debt, thereby eliminating the need for future taxes to service
    that debt.” I have been seeing this argument advanced in other places as well recently. Speaking only for myself, this has me looking more and more closely at sovereign fixed income instruments issued in the currency of the country of origin that are both highly secure and still pay real interest. Am I naive to assume that a continuing trend toward reducing the interest paid on US treasuries is likely to weaken the dollar on the international currency exchange markets?

  3. Bruce

    Diogenes that is most likely a goal of the Fed – weaker currency. Unfortunately it is a goal of every major trading bloc, so it’s a sort of a weird Nash equilibrium that will only in the long run benefit hard assets.

  4. Jim Haygood

    ‘Since the real point of QE2 is to cut longer-term rates …’

    … that’s exactly why it won’t work. When lending expansion is not happening (evidently because borrowing is not rate-constrained), lower long rates deepen the pall over savers, including pension funds who can’t get anywhere near the returns they assumed. Corporations and governments forced to ante up higher pension contributions will be dragged down even farther.

    There’s also the expectations effect. Lower long rates flatten the yield curve (that’s ‘yieldoh cahboo’ in Japanglish). A 2% yield on the 10-year note would scream ‘Deflationary Depression’ to most observers, including me.

    QE has become counterproductive. But like coke-addled lab rats, central banksters keep frantically pushing the ‘coupon pass’ button long after it’s stopped dispensing any economic reward.

    Although it did uselessly expand its QE program, the Bank of Japan also understands that the ticket out of deflation is to weaken the J-yen. I have advocated that the Fed do the same — acquire international reserves in place of more T-bonds.

    Bolstering reserves is certainly more feasible, in institutional and statutory terms, than turning loose Bernanke to daytrade the Nasdaq. The pitiful $50 billion of euros and J-yen shared by the ESF and Fed would barely cover a week’s worth of imports. Prudent? I reckon not!

  5. Siggy

    If one parses the QE actions of the Fed it seems to me that the objective is to inflate the money supply at the rate of 3.5% per year; or, the effect over a 5 year period will be to reduce the purchasing power of the money supply by 15%.

    All the while this is going the Fed seems to be hoping that the rest of the world, mainly China, is improving their purchasing power by 15%. The idea is to bring to parity the living standards of China and the US.

    If that happens, then China’s ability to use a labor cost arbitrage to industrialize itself and create the basis for expanding domestic consumption that will support the created manufacturing sector will come to a halt. The Fed is attempting to trap China into a manufacturing based cul de sac. It is no wonder that China is concerned about the purchasing power of the Treasury debt that it holds.

    You gotta love American ingenuity and at that I wonder just how badly some erudite folks at the Fed have been abusing their meds.

  6. shrek

    One way or another the level of debt will come down. We can either do it systematically like what they are attempting in Britain or have an out of control Weimar Germany scenario.

  7. Anthony

    I never comment but feel I must. The point of quantitative easing was not to raise asset prices or lower interest rates – it was to replace the disappearing spending power based on debt with new spending power based on creating new cash. It so happened that the new spending power going into the system chased assets which caused people who woned those assets previously to chase other assets. But the POINT was to create more cash based spending power as some of the old spending power based on debt went away.

    1. stf

      The problem is QE can’t do that since it’s by definition an asset swap, not a helicopter drop of money.

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