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Mutual fund manager, CFA, registered investment advisor, macro
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“Depend upon it ... there comes a time when for every addition of knowledge you forget something that you knew before. It is of the highest importance, therefore, not to have useless facts elbowing out the useful ones.” - Arthur Conan Doyle

On May 23rd of this year, I published an article titled "QE3 Is You and Me: How Investors Can Replace the Fed" in which I argued that "the herd will replace the Fed in the bond market this time around." Much of my reasoning at the time had to do with (1) the still overwhelming bearishness that existed toward bonds, and (2) the fact that the bond/stock price ratio had been trending higher since mid-February. Further in the article, I put up a comment arguing that "if 10-year rates dip below 3% again it might cause a mini-panic in risk assets and accelerate a more formal QE-lite by the Fed."

I then followed up on that article on June 27 with “QE3 is You and Me: Implications on the Summer Crash” in which I furthered the argument for lower yields and pinpointed that “despite QE2 ending, bond rates have continued to trend lower in a troubling way.” Now, with markets having collapsed as I have been warning about since my June 8 article, in which I first called for a summer crash, all the debate is on whether the Fed will initiate QE3.

To me, this is a silly argument. QE3 is already happening, and without the Fed. Bond rates are once again at historic levels. What would QE3 ultimately do when bonds have already rallied in the absence of the Fed to begin with? The message of the bond market remains clear – we are in a deflationary pulse. And for those keeping track, Marc Faber of the Gloom Boom and Doom Report has published alongside his Monthly Market Commentary two analysis pieces I wrote for him in which I argued for a deflation scare and collapse in risk assets as early as February.

Will the Fed initiating QE3 ultimately matter? I am unclear, but rates are already incredibly low. To push rates lower would be admitting that we face significant deflationary headwinds. And as to the bond/stock relationship, take a look at the price ratio below of TLT relative to IVV. As a reminder, a rising price ratio means the numerator/Long Bond/TLT is outperforming (up more/down less) the denominator/S&P 500/IVV.

Click to enlarge



I have been arguing for some time that the ratio above needed to reach 1 given where absolute yields were. I suspect that if the Fed does initiate QE3 to try to push long rates lower, we may see the above relationship blow past that.

Source: 'QE3 Is You and Me' Redux and the Summer Crash of 2011

Additional disclosure: The author, Pension Partners, LLC, and/or its clients may hold positions in securities mentioned in this article at time of writing.