Fed's Announcement Caused Major Rally In the Debt Markets

Yesterday’s announcement that the Fed would purchase $300BN in long term Treasuries and boost its purchase of mortgage debt by $750BN to a projected total of $1.45TN caused a rally in the debt world that, at least in the case of the 47bps drop in the yield of the 10 year note, had not been seen since 1987.

It would seem, however, that the move was not totally unexpected. The Bank of England instituted its quantitative easing program last week with purchases of 2BN pounds worth of Gilts on March 11th followed by the announcement of additional 5BN pounds purchase scheduled for today. Yesterday the BOE unanimously voted to cut the base rate (equivalent to our Fed Funds rate) to 0.5%.

Brian Edmonds, head of interest rates for Cantor Fitzgerald was quoted this past Monday as saying that the BOE move “probably steps things up a notch” for the Fed. “I don’t think they have much choice here.” He went on to say when asked if the Fed would announce such a program after this week's two-day meeting.

If you are wondering what is to be expected after such a historic move, a look across the pond might yield some clues. European companies offered a total of E10.0BN worth of bonds in the last week alone with issues from Phillip Morris International (PM), Deutsche Bank (DB), Lufthansa (DLAKY.PK), Daimler (DAI), E.ON (EON) and Telefonica (TEF). This pushed the total for this year to E100BN vs. E105BN for all of 2008.

CDS and cash market spreads did not move appreciably yesterday but this is not unusual on days when the volatility in the Treasury market is high. Similar to what occurs in the stock market when there is intervention, correlation has a tendency to move towards 1.0 while dispersion goes in the opposite direction (0.0). If anything, a sharp rally in Treasuries usually causes some nominal widening of spreads on cash corporates as it can take a day for that market to catch up.

Mohamed El-Erian, the co-top-everything at Pimco, but most probably single heir apparent to Mr. Gross, was on the little screen speaking with Maria Bartiromo shortly after the close yesterday. In a possible attempt to draw the heat away from CNBC’s own Jim Cramer, Maria attempted to lure M. El-E into the bottom picking game asking him if he would put his own money in the stock market at the moment.

Cool, calm and collected, Mohamed explained that while the Fed’s move would help increase liquidity in the debt markets it could take some time for these actions to filter through to the equity markets.

This is in line with previous comments we have heard from the folks at Pimco and almost every other guest given the chance to voice their opinion in the media.

If there is a speck of light at the end of the tunnel it is that Ben Bernanke, for whatever problems his actions cause down the road (those pesky unintended consequences), is working to stem the spread of this crisis with tools rarely if ever used before.

As Dick Hoey said on Bloomberg TV yesterday, “If you have to use swamp water to put out a house fire you can’t worry about what it will do to the curtains.”

Enjoy the week.

Comments

[Mr. Big:]

....and the bubble grows bigger.....
It will be the pop that will bring America to her knees...

Why are these leaders exacerbating the problems? Only history will tell. Twenty years from now, our children will read it in the history texts....under the section "The Fall of the American Empire".

Mar 19 09:26 AM

[Chris B:]

What's interesting is this: The Fed is doing all the right things to increase inflation. However, bond prices at a given yield usually move inverse of inflation expectations. Totally oversimplified example: a bond yielding 5% will decline in price until the yield is 7% when inflation expectations increase by 2%.

Yet, the exact opposite happened this time. Perhaps because bonds were discounted based on default risk and the additional liquidity reduced that default risk. Perhaps because bonds are trading only on the basis of default risk with the assumption of 0% inflation still in place. When that assumption collapses, so could bond prices. CPI and PPI are already well in the positives, but it's not clear if anybody has yet noticed.

For now, I think I'll stick with TIP for my bond allocation.

I'll interpret Mohamed El-Erian's comment to suggest that bond prices have already been pushed up, and the major remaining upside is to equities. Yes, it could take some time, but it's coming.

Mar 19 10:58 AM

[mac.barron:]

Robbing Peter to pay Paul.

Mar 19 11:03 AM

[yukonmike1:]

Paul will always agree with that! And vote for you too...

Mar 19 11:49 AM

[mac.barron:]

Yeah, but Peter's gonna' be pissed and come kick your ass

Mar 19 12:18 PM

[Tradememe:]

What the Fed is doing right now is treating the symptoms not the disease.

Mar 19 12:19 PM

[yukonmike1:]

Not if there's 9 Pauls for every one Peter...Peter better move to Argentina.

Mar 19 05:23 PM

[MarbleHost.com:]

I am agree with you Paul. Nice post.

Mar 27 02:43 AM

[MarbleHost.com:]

I am agree with you Paul. Nice post.
www.marblehost.com

Mar 27 02:44 AM

[john s. gordon:]

trademem - treating the disease offends too many entrenched interests. bandaids are easier. look @ the tax code for an example of multiple bandaids over the years.
> jack

Apr 19 11:03 AM