We were sent a good commentary piece recently by FX Concepts - the headline was "What happens when QE2 ends?": highly topical since the US Federal Reserve has already announced that it will conclude its "large scale asset purchases" by the end of June. The liquidity that the Fed has been injecting into the system since the beginning of the Quantitative Easing programme has been an important factor in supporting sentiment (if nothing else) since the beginning of the first QE programme in March 2009. Since this programme coincided with the bottom of the market earlier that month, it's a legitimate question as to whether the ending of the latest programme - QE2 - at the end of June will represent a topping out of markets as either liquidity stops growing so dramatically, or is withdrawn over time.
The FX Concepts piece describes the situation well. They note that in the last 3 months, Fed purchases of US Treasuries has soaked up 94% of the Treasury's total issuance of debt in the form of Bonds and Bills. That leaves, apparently, less than $10bn a month to be absorbed by "the market". Obviously from July 1st, then, "the market" will need to subscribe to an additional $157bn in order to take up the slack. Ordinarily, once would assume that interest rates will have to rise to encourage such investors of the attractions of such debt, particularly in comparison with places like the Eurozone, where the ECB has already begun tightening.
FX Concepts, however, makes an interesting point on the USD: what happens to it when foreigners are being expected to increase their purchase of USD debt...? Normally, increased large scale foreign purchases of US assets to the tune of an extra US$157bn a month, could be expected to boost the USD: for the same reasons that the Fed's purchases replaced foreign buyers with a single domestic one and resulted in steady USD declines through out the period of QE/QE2.
FX Concepts also notes that on a global basis, the withdrawal of this excess liquidity means a squeeze on the availability of money and therefore higher interest rates: not good news for struggling property markets in the US.
If the withdrawal of the Fed as the main buyer of US Treasuries puts pressure on the banks to be more aggressive in lending in order to replace the risk-free revenue they are losing, then the positive trade-off could work well. If not, and interest rates go up, with no corresponding increase in lending, then the global economy could go into a stall.
Big stakes. Maybe we'll know in July which way things are going to go...
Steve
e-mail: steve.davies@javelinwealth.com
contact: +65 65577185
website: http://www.javelinwealth.com
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