Analyzing the QE2 Announcement Aftermath

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Includes: BND, DIA, FXE, IEF, IRL, QQQ, RSX, SPY, TMV, UDN
by: The Housing Time Bomb

The Fed stepped up to the plate and announced QE2 as expected. Here is the money quote from the FOMC statement:

To promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to expand its holdings of securities. The Committee will maintain its existing policy of reinvesting principal payments from its securities holdings. In addition, the Committee intends to purchase a further $600 billion of longer-term Treasury securities by the end of the second quarter of 2011, a pace of about $75 billion per month. The Committee will regularly review the pace of its securities purchases and the overall size of the asset-purchase program in light of incoming information and will adjust the program as needed to best foster maximum employment and price stability.

My Take:

I don't even know where to begin. Let's start with the last statement where the Fed will "adjust the program to foster price stability".

Price stability? Really? Take a look below and tell me how that worked out yesterday?

Let's start with the 30 year bond following the announcement ():

The 10 year wasn't much better ():

Oh and the dollar? That fell too after announcing that we will print $600 billion more dollars out of thin air ():


Take Continued:

Another question. How is any of this "fostering maximum employment"? Since when did the Fed start creating jobs? How many did QE1 create? With unemployment at near all time highs you already have the answer to that one.

I could easily start ranting like a lunatic right now but I am going to try and refrain from doing so. My mild rant above is all you are going to get.

However, it is what it is, so let's break down what happened yesterday.

Stocks

The trading robots were once again able to keep things contained. You can expect to see less and less stock analysis here at the THTB. There is nothing to analyze.

The computers rule Wall St and their trading volumes morph anyone else that's currently involved in the markets. As a result, whatever the trading algos decide to do on any given day is where the market will move.

This can't last forever because the trading algos are not prepared for the "black swans" that inevitably will hit this market. The Fed made sure that we will see one of these swans after yesterday's spending spree.

The market is now filled with price distortions, bubbles, and fear. One of these will inevitably create a selling panic, and god only knows how the trading robots will react to this....Flash Crash Part 2 anyone?

Bonds

This is where the action was yesterday. The robots can't control the credit traders (who are a much more sophisticated bunch despite being human).

Yields soared and bond prices collapsed on the QE2 news. One might have expected the exact opposite price action in bonds. I think the credit traders were OK with the $600 billion number (as absurd as that sounds). However, I don't think they liked the open ended language that followed it where the Fed promised to adjust their program if needed.

This was very aggressive on the Fed's part. They should have just announced the $600 billion and then kept their mouths shut. At most, they should have said that they will continue to monitor the situation. They didn't need to discuss "adjusting the program" if needed.

This was a sign of desperation in my view, and the bond market responded by immediately worrying about money printing and massive inflation/hyperinflation(as they should).

As a result, they began dumping Treasuries, and the selling got more aggressive as you went up the curve because the risk of high inflation is much more damaging to longer dated Treasuries like the 30 year bond because of the duration of the investment.

The Bottom Line

We are now officially in uncharted waters. The whole market at this point is now being propped up by toothpicks, the Fed, and trading robots.

The US dollar was relatively quiet given the action in bonds. There were reasons for this. Things in Europe are detiorating rapidly. One of Ireland's largest banks CDS swaps are now pricing in a >60% chance of default. Here are the bank spreads below ():

This obviously pressured the euro today and helped the dollar. Russia also didn't help things after announcing it will exclude Ireland and Spain from it's sovereign wealth fund actvities.

All in all, things are going to hell in a handbasket. There is no other way to interpret things although the stock pumping puppets on CNBC would strongly disagree.

But hey, let's try and look at the bright side....Stocks were up 26 points. Yahoo!!! Hooray for the robots!

Disclosure: No new positions taken during the time of publication.