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Tuesday, August 10, 2010 8:12 PM


Quantitative Nothingness and the Yield Curve's Reaction


While most eyes were focused on the FOMC meeting, I did something far more enjoyable, and probably far more sensible as well. I went golfing.

Upon return I see a new but meaningless twist in Bernanke's statements in the latest FOMC Press Release.

Information received since the Federal Open Market Committee met in June indicates that the pace of recovery in output and employment has slowed in recent months. Household spending is increasing gradually, but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software is rising; however, investment in nonresidential structures continues to be weak and employers remain reluctant to add to payrolls. Housing starts remain at a depressed level. Bank lending has continued to contract. Nonetheless, the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, although the pace of economic recovery is likely to be more modest in the near term than had been anticipated.

To help support the economic recovery in a context of price stability, the Committee will keep constant the Federal Reserve's holdings of securities at their current level by reinvesting principal payments from agency debt and agency mortgage-backed securities in longer-term Treasury securities.1 The Committee will continue to roll over the Federal Reserve's holdings of Treasury securities as they mature.
Quantitative Nothingness vs. Quantitative Easing

Bernanke's pledge to hold the Fed's balance sheet constant is certainly a new twist. However, given that quantitative easing will not do a damn thing as discussed in Quantitative Easing Take II; Uncharted Territory it is silly to think that Quantitative Nothingness will do anything.

When the equity market will figure this out remains a mystery, but the treasury market seems to have figured it out already.

10-Year Treasury Yield Hits 16-Month Low

If the Fed's action was supposed to help the economy grow, long-term yields actually should have bounced. Instead, they reached a new low for the move.

While some will scream manipulation, and clearly it is, the key point to remember is the Fed cannot change the trend.

Quantitative Nothingness aside (Quantitative Constancy if you prefer) treasuries were poised to rally in the face of extended economic weakness, and they did just that.

Yield Curve as of 2010-08-10



7-year Sweet Spot

Once again the yield curve flattened with the "sweet spot" this time being the 7-year treasury. The 30-year long bond barely budged.

Normally, the further out one goes the bigger the rally (or loss) in response to economic news. It will be interesting to see if the 30-year long-bond can catch up.

Yield Curve May 2008-Present



click on chart for sharper image

A couple things stand out on the above chart.

1. The 5-year treasury yield is approaching all-time record lows and is now back to where it was in January of 2009.

2. The spread between 10-year treasuries and the 30-year long bond continues to widen

I suspect a major player continues to put on a long-10 short-30 trade. I can easily be wrong on that. The question is "where does the spread go from here?"

A continued bullish flattening of the curve, with the long-bond playing catch-up is certainly not out of the question.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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