In my previous post, I stated that POMO targets 3 fixed income areas: 1) treasuries 2) GSE debt and 3) GSE MBS debt.
Analysts predict that Bailout Ben will end quantitative easing by the end of this August (to be announced at the next FOMC meeting). Specifically, they mean the treasury purchase program.
However, the issue of #2 and #3 remains silent in much of the press coverage.
It is my belief that the Fed will continue buying/backstopping GSE and GSE MBS debt. The reason is simple - to maintain downwards pressure on housing interest rates or more specifically to prevent rate spreads from widening too far in the ABX market. After all, Treasuries are a relatively small part of POMO quantitative easing operations. The bulk of the Fed's purchases are in monetizing the loan portfolios of banks which is a program that runs in the TRILLIONS.
KEY POINT: Any actions the Fed undertakes HAS to please America's #1 creditor, China.
This means that fiscal authorities have to pay more than lip service to a strong dollar policy. They may try to find a way to bundle the commercial and residential loans (CMBX and ABX respectively) into some kind of new bailout program but any such measures won't fool the currency markets for long.
Thankfully for the US, the rest of the "spender" nations such as the UK and EU bloc are in even worse shape. Bloated budgets, anemic capital markets, flagging tourism (a big revenue generator for socialist Europe) and a weak consumer base mean that their governments will likely be forced to revert to deeper q.e. programs by the fall.
The spender-lender dynamic is a well explored theme in this web site where "spender" nations (e.g. G8 minus Russia and Japan) function as safe haven flows for "lender" nations (emerging markets plus Russia and Japan). Lenders are characterized by large current account surpluses that they use as a form of state funded mercantilism to foster export driven growth. In times of stress, lender states direct their surplus funds into the capital markets of their former colonial masters.
This means that any sort of quantitative easing programs undertaken by either set of nations will lead to a weakening of their respective currencies and a strengthening of the dollar vis a vis capital flows. Such macro weakness will also serve as a buffer to support treasury yields from rising too quickly.
At this point it is too premature to say what the catalyst would be for a surging dollar/lower bond yields but weak factory orders from US and European retailer orders for the holiday season could be a potential trigger. A lack of orders would lead to a slowdown in commodity prices for industrial inputs like oil, iron ore, and copper . . . .which would negatively affect other "lender" nations like Russia, the Middle East Gulf Coast states, Brazil, and Australia.
Monday, August 10, 2009
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