The Fed's Quantitative Easing is Having a Curious Effect

On March 18th, the Federal Reserve announced that it was going to perform 'Quantitative Easing'. The plan is to buy treasury bonds on the open market. This would have two effects. First, it should increase the money supply which does provide, in fact, a temporary boost to output (although a misallocation of resources that reduces long term growth). Second, it should lower interest rates, obstensibly to lower mortgage rates and induce consumers to purchase some of these unwanted houses around the country.


Well, an interesting thing has happened since this announcement. 30-yr Treasury yields have been rising and are now at their highest point so far this year. Is this a trend? Is this the beginning of the dramatic and inevitable rise I expect in borrowing costs? We'll see...




Source


Why is This Happening?


China is selling long-term U.S. Treasury Bonds in favor of short term t-bills. This has driven yield on short term t-bills down while putting upward pressure on yields for treasury bonds.


According to Bloomberg:


Rates on three-month bills turned negative in December for the first time since the government began selling them in 1929 as investors sacrificed returns to preserve principal. After increasing at the start of the year, rates have dropped 0.20 percentage point since the beginning of February to 0.13 percent.

Demand for bills is rising again because investors including foreign central banks are snapping up the shortest- term U.S. securities as the Federal Reserve buys Treasuries to drive down borrowing costs in a policy of so-called quantitative easing. China, the largest U.S. creditor, with $744 billion of debt, has questioned the practice and shifted purchases to bills from longer-maturity securities.

“There’s a group of investors out there who are looking at what the Fed is doing and the policy action they’ve taken and the asset purchases, and saying ultimately this is inflationary,” said Stuart Spodek, co-head of U.S. bonds in New York at BlackRock Inc., which manages $483 billion in debt. “You’re going to invest in very short-term bills because you absolutely need not just the quality but also the absolute liquidity.”

China bought $5.6 billion in bills and sold $964 million in U.S. notes and bonds in February, according to Treasury data released April 15. It was first time since November that China purchased more bills than longer-maturity debt.