“Whatever it takes”

Spanish and Italian 5-year government bond yields are now below those of the US.

Bond Yields

There is still a real threat of deflation across Europe and some countries are already experiencing deflation, but “Whatever it takes” has had a huge impact on debt markets.

Government Bond Yields

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Radical Softening of Stance on Contested Policy

Bundesbank’s president Jens Weidmann seems to have changed his view on QE.

“Bundesbank President Weidmann said ECB could consider purchasing euro zone government bonds or top-rated private sector assets marking radical softening of stance on contested policy. The European Central Bank could buy loans and other assets from banks to help support the euro zone economy, Germany’s Bundesbank said.” (Reuters)

Unclear How Fed Bond Buying Works

“Federal Reserve Bank of New York President William Dudley said Saturday some key aspects of how the central bank’s bond-buying stimulus effort works remain mysterious. Referring to the Fed’s bond-buying stimulus program, Mr. Dudley said, “we don’t understand fully how large-scale asset-purchase programs work to ease financial market conditions — is it the effect of the purchases on the portfolios of private investors, or alternatively is the major channel one of signaling?” (Market Watch)

QE Tapering

“We would be surprised by QE tapering move at December 17-18 FOMC meeting – our central forecast for first tapering move remains March, although January is possible. (i) Although employment growth has improved, core PCE inflation has fallen further and now stands 90bp below the Fed’s target. (ii) Only a minority of forecasters seem to expect tapering in December, which itself raises the hurdle for a move. (iii) We believe Fed officials will not want to surprise the markets on the hawkish side with the first tapering move when inflation is as low as it is. (iv) We also suspect that the committee has not yet decided on the changes to the forward funds rate guidance that are meant to accompany the tapering announcement.” (Goldman Sachs)

Fed will soon buy more government bonds per year than the Federal government’s net borrowing requirement and on top of that, Fed currently increases its holdings of government bonds of USD 540bn per year. That may be reason enough to start tapering sooner than later.

Bond Purchase

“The two biggest supporters of US Fixed income are the FED and foreign central banks. The FED is still buying roughly 80 % of all net bond issuance and approximately 60 % of all 10y issuance. In addition, foreign central banks have re-added the UST holdings they cut (and then some) from the summer.” (Goldman Sachs)

Percent of incremental duration of Treasury absorbed by the Federal Reserve.

Percent of Incremental Duration of Treasury absorbed by the Fed

“We now hold roughly 20 percent of the stock and continue to buy more than 25 percent of the gross issuance of Treasury notes and bonds. Further, we hold more than 25 percent of MBS outstanding and continue to take down more than 30 percent of gross new MBS issuance. Also, our current rate of MBS purchases far outpaces the net monthly supply of MBS. We own a significant slice of these critical markets.” (Dick Fisher, Dallas Fed)

Gordian Knot

Owning a Significant Slice of Critical Markets

Federal Reserve have been absorbing almost all of the supply of US Treasury debt lately. Even a modest reduction (tapering) could therefore effect interest rates quite negatively. Many of today’s bond fund holders have never experienced a rising interest rate environment.

“The two biggest supporters of US Fixed income are the FED and foreign central banks. The FED is still buying roughly 80 % of all net bond issuance and approximately 60 % of all 10y issuance. In addition, foreign central banks have re-added the UST holdings they cut (and then some) from the summer.” (Goldman Sachs)

Percent of incremental duration of Treasury absorbed by the Federal Reserve.

Percent of Incremental Duration of Treasury absorbed by the Fed

“We now hold roughly 20 percent of the stock and continue to buy more than 25 percent of the gross issuance of Treasury notes and bonds. Further, we hold more than 25 percent of MBS outstanding and continue to take down more than 30 percent of gross new MBS issuance. Also, our current rate of MBS purchases far outpaces the net monthly supply of MBS. We own a significant slice of these critical markets.” (Dick Fisher, Dallas Fed)

Gordian Knot