Monday, April 20, 2009

Short rates are not due to China, Fed QE

In a continued trend of low short rates, Bloomberg reports that not much has changed since late last year. This time around, they are ascribing it to central banks snapping up bills in anticipation of Fed QE, specifically China, rather than reduced risk sentiment on the part of investors.

We have to wonder at the logic that Dan Kruger is using in this case. Since when do central banks play market moves in anticipation of Fed policy decisions? Why would they express this through short rates when most QE has been happening on the long part of the curve? Why wouldn't investors be reacting to a decreased risk sentiment in light of the recent equity rally which has parked most smart money on the sidelines?

An interesting piece on the side - China was reported to have bought $5.6B in bills and sold almost $1B in notes and bonds in February. This move away from long exposure on the duration curve can be exhibited a number of different ways. The conspiracy theorists may see this as a sign that China wants a shorter term lockup because they are hatching a grand plan to move to a commodities based currency/IMF basket/other conspiracy and they are going to be deploying this in the next 6 months to a year. Or it could be a repositioning of their portfolio on their beliefs on the current yield curve. Or it could be some small reason, given the overall exposure that they have to Treasuries. Either way, it is worth watching to see if this trend continues over the next few months.

Finally, we have to believe that middle part of the yield curve has to perk up - the 1 to 5 year yields just do not seem sustainable. For example, pricing in a 1% yield between 2-3 years does not seem reasonable especially given what's being priced in for inflation, demand and other macro factors.

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