Tuesday, October 12, 2010

The Pied Piper Plays On

From the playbook used so many times before, comes the strategy of letting the markets ease for the Federal Reserve long before any action is actually taken. The Fed may announce a decision to resume the buyback of US Treasuries within the next month but the size of the program is likely to remain indefinite. The US economy is limping along and a combination of monetary as well as fiscal policy will continue to be used to take action but the efficacy of monetary policy with rates already at zero is questioned by more than a few. Keeping rates low for an extended period of time pushes investors out the yield curve and down the credit curve so buying back Treasuries is one way of accomplishing that task. It may not even require that many purchases as the expectation of more buybacks will keep rates low. When the economy shows some signs of a stronger recovery, the buybacks can be postponed for a while and eventually halted. The Fed has by some people's count about $500 billion of principal and interest coming to it from its mortgage backed securities portfolio in the next year so the buybacks won't increase the debt as long as they stay within that range. It will merely be a reinvestment of the portfolio. A lot of the buyback program is priced into the market so it seems the upside to buying US Treasuries is limited. Investment grade credit doesn't look too enticing either as absolute yield levels remain unattractive and spreads appear vulnerable to a wave of supply from issuers looking to lock in long term financing at these historically low interest rates. US high yield looks good as investors don't need growth from companies, they merely need to get paid back. As long as the economy doesn't fall off a cliff and markets remain liquid high yield will perform, though most of the relatively easy money has been made.