October 30, 2014 ended the third and final round of Quantitative Easing. Right? The announcement was couched in a hyperlinked document at the end of the FOMC statement. Those who made it through the statement and still felt like reading, realized that the end of QE was not as finalized as one may have expected.
The sub-statement, titled “Statement Regarding Purchases of Securities and Agency Mortgage-Backed Securities” started simply enough—the FOMC had instructed the trading desk to conclude the current asset purchase program by month-end October. In the next sentence, the Fed signaled that it would continue an asset purchasing program by:
1. Continuing the policy of reinvesting principal payments from Agency debt and MBS holdings to purchase agency MBS and
2. Rolling over maturing U.S. Treasury securities held in the SOMA (System Open Market Account) portfolio i.e. the Fed’s balance sheet. In our view, this is an extension of monetary accommodation. While this may not be QE in word; this seems to be QE in deed.
While we will not see the tentative schedule of Fed trades of MBS in the To-Be-Announced (TBA) market until November 13, we suspect that the purchase of MBS, while small, will not be insignificant compared to the until recently approved purchases through POMO (Permanent Open Market Operations), i.e. asset purchases. We must remind investors that reinvestment and rolling is a perpetuation of QE policy. These policies existed during QE. However, while interest income should remain relatively stable, the prospects of maturing debt within the SOMA grow larger.
On the other side of the easing argument is the possibility that the Fed is already, in a way, tightening. Recall that the Fed has been neutralizing some debt issuance. At the high point of QE3, the purchase amount was $85 billion/month. While the Fed has tapered, i.e. scaled back asset purchases, we are not sure the U.S. treasury is following suit in scaling back issuance. We, unfortunately, are in soothsaying territory as we do not have the ability to travel into the future to tell our readers whether the U.S. Treasury scales back U.S. debt issuance in concert with the end of QE.
If U.S. treasury issuance exceeds the neutralization that has occurred through asset purchases, then this implies in effect a tightening measure. Simply put, if the U.S. is issuing more debt than the Fed was previously cancelling out, then there is a larger supply of U.S. debt, which implies growing inflation (this remains one of the only rational arguments which suggests that tapering may have been tightening). However, we must note that the yield on the U.S. ten year treasury has remained relatively flat, which advocates for the argument that there is ample demand to keep a lid on Inflation.
As a consequence of low yields in the midst of a tapering in the Fed’s asset purchasing program, we have suggested one should be on the lookout for a strengthening U.S. dollar. Time will tell whether the suggested push and pull of derivative tightening/easing will lean one way or the other. It may be a wash. However, our U.S. dollar bullishness has become more pronounced due to the recent movements by the Bank of Japan’s (BOJ) Haruhiko Kuroda and the European Central Bank’s (ECB) Mario Draghi.
The BOJ pushed forward a massive increase in monetary accommodation by stating that they will extend their current easing program to 80 trillion yen per annum ($724 billion). This equates to roughly $60 billion in asset purchases per month. Many feared that tapering QE3 by the U.S. Fed would end a global policy of easy money. In the same week that the U.S. Fed announced the end to QE3, the BOJ seemed eager to replace the accommodative monetary slack. The commitment to purchase nearly double the issuance of new bonds is striking. Assets are not limited to debt purchases, and the Japanese yen is at a six-year low versus the dollar.
The last of the G3 central bankers, Mario Draghi, seems determined to devalue the euro quickly through sovereign bond purchases. While still in legal limbo, Draghi is pushing forward with the Targeted Long-Term Refinancing Operations (TLRTOs). He stated recently the intent to buy Asset-Backed Securities and Covered bonds for the next two years.
The newly introduced Single Stability Mechanism (SSM) and the Single Resolution Mechanism allows the ECB to coordinate closer with Germany to monitor bank activities creating an ersatz fiscal union. If Draghi can continue to entice the Germans to work with the ECB, we should expect a QE program coming out of the European Union. A true sovereign-based QE, backed by some sort of fiscal union should be bearish for the euro.
With two G3 currencies heading towards depreciation through QE, we believe dollar strength will compound expectations of its rise post taper. The strengthening of the dollar associated with the end of QE has more support as other currencies depreciate against it. We suggest buying U.S. dollar denominated assets.
We continue to favor U.S. bonds in this environment, but we suggest that equity investors should be on the lookout for U.S. companies that are import-oriented. We recognize that the long dollar trade has become crowded, and short squeezes in either the euro or yen may negatively affect valuation in the near-term. Over the long term, amidst global monetary accommodation, we believe patient investors will be rewarded through long dollar positioning. Remember, Not All Bonds Are Created Equal.
Good Fortune!
Bob Andres is editor of The Andres Review and founder of Andres Capital. Bob’s career includes stops as: chief investment officer at Merion Wealth Partners, chief investment strategist at Envestnet (PMC division), co-founder at Martindale Andres & Co., a firm he grew to $2.4 billion before its sale, President at Merrill Lynch Mortgage Capital, etc. He has been quoted and featured in various media: CNBC, Fox Business, Barron’s, Institutional Investor, etc.
