Pushing on a Slinky

Pushing On a Slinky


As expected the Fed launched QE2. Not quite as expected the Fed announced only $600 billion in U.S. treasury securities purchases between now and June 2011. That works out to about $75 billion per month. The Fed will also reinvest the proceeds from QE1 it will receive during that time to bring the total in the $850 billion to $900 billion range. This is a far cry from the $1 trillion to $2 trillion in new capital many were expecting. Notably nearly absent from QE2 purchases was very long end of the curve (longer than 10 years). Some dealers, such as Goldman Sachs, voiced opinions calling for asset purchases on the extreme long end of the curve. Instead the Fed chose to keep the average duration of the bonds it purchases to the five to six year range spreading purchases nearly evenly from two years to ten years out. The Fed also left the possibility of further easing open.

Aside from keeping rates low, possibly for the next year or two as far as Fed Funds are concerned, and weakening the dollar what has the Fed accomplished? Probably not much, but what it did accomplish will probably keep the economy out of a double dip recession. Some people have described QE2 as pushing on a string (as it would have almost not effect on the recovery). I like it to pushing on a Slinky. When on pushes on a Slinky motion is transferred, but not very efficiently. There is much absorbing of the motion by the spring. The economy will absorb much of this QE because the Fed can keep borrowing rates lower, but it cannot make lenders lend, borrowers borrow or investors invest in mortgage-backed securities.


What about inflation. Sure, the weak dollar could cause food and energy prices to rise, but since the demand curve for such commodities is relative inelastic, they will only hinder consumer spending further. When is housing making a comeback? When home prices fall far enough to where people have enough money saved to make a 10% or 20% down payment. When are jobs coming back? When U.S. labor costs (including taxes and health care) are low enough that businesses can add U.S. workers instead of new equipment or moving jobs overseas. In other words, low rates, high unemployment and sluggish growth will be with us for a very long time.

Stay away from LIBOR-based floaters. Coupons on these bonds and preferreds promise to remain at or near there floors. There will be better times to buy that kind of structure. Most TIPS are rich too. Buy only the 1.25%due 7/15/20 and only in moderation for hedging purposes. Ladder one’s portfolio two-years to 10-years (as I have been saying for a while and how the Fed is doing). Adding some step up bonds for the purpose of increased yield and cushion against rising rates could also be a good idea.

Nonfarm Payrolls on Friday, I can hardly wait.