The Fed plans to begin its $300bn purchase of longer-term Treasuries today.
From the New York Fed:
NEW YORK-The Federal Reserve Bank of New York today released a tentative operation schedule for its purchases of longer-dated Treasury securities through April 3, 2009, and frequently asked questions (FAQs) about the purchases.
The first outright Treasury coupon purchase will be conducted on Wednesday, March 25, 2009, and will settle Thursday, March 26, 2009. Results will be posted on the New York Fed’s website following the operation.
Starting on Wednesday, April 1, 2009, and continuing every two weeks, the New York Fed will issue a tentative operation schedule for its purchases of longer-dated Treasury securities, including the maturity sector or sectors to be targeted.
The full (tentative) schedule is here.
Here’s how Merrill Lynch/Bank of America analysts Michael Cloherty and Joseph Shatz see the purchases going down:
Sawtooth yield pattern. We expect to see a pattern of the market trying to get long for the Fed’s purchase days, and short for the auctions. The market already has been more likely to selloff on Treasury bond and note auction days than on other trading days. On days of Treasury bond and note auctions from 9/1/08 to 3/19/09, the Treasury market (using the current 10-yr Treasury note as a proxy for the market) sold off 66% of the time, while the market actually rallied on 58% of the days on which there were no T-bond and T-note auctions during the same time period (see J. Shatz, “US Treasury supply begins to have an impact”, Global Rates Strategy, 3/9/09). The Fed’s Treasury purchase program could accentuate this pattern in ways such that the market would tend to sell off on auction days and rally on Fed purchase days.
While the Fed’s new quantitative easing measure is aimed at force feeding liquidity into the financial system in the short-term, there are, of course, more long-term risks. Merrill’s Michael Cloherty highlights one thing in particular, in a parallel with Japan’s QE experience in the early 2000s…
Building on the movements in Japan we can see similar risks in the US treasury markets today. Like the Bank of Japan in the first half of the decade, the Federal Reserve is expanding its balance sheet and thereby increasing excess reserves held at the Fed and with its most recent action is purchasing Treasuries to lower back-end rates. … as yields move lower the risk to returns becomes increasingly skewed towards sell-offs. Meanwhile, similar to what happened on the onset of quantitative easing [in Japan] vol has fallen sharply across the surface.
Those movements can be seen in these two charts from Merrill/BoA, showing Japanese lending rates and volatility.
John Richard, writing in the FT’s Economists’ Forum, has a good written account of what happened.
… the bond market during [Japan's] quantitative easing was anything but smooth. The process ignited a bond bubble, whose eventual collapse destabilised financial markets, even threatening Japan’s hard-earned economic recovery. Long- term interest rates began to plummet in the spring 2002, with 10s reaching 0.48 per cent in June 2003, down 120 basis points over the year.
The yield curve experienced a rolling flattening in which successively longer maturities tightened down on the zero policy rate.
When the bond-bubble burst in June 2003, rates soared and the curve steepened sharply. This created what in Japan is still known as the Var-shock because of the sudden rise in yields and the accompanying jump in volatility triggered when banks, which were using similar risk management models, tried to dump Japanese government bonds at the same time.
Yet another something to think about as the Fed begins buying then.
Related links:
Since when has the Treasury ever pre-announced…? – Credit Writedowns
Quantitative easing: Lessons from Japan – FT Economists’ Forum
Analysts react: Dollar dead, Fed credibility shot - FT Alphaville
Rescuing banks, then Treasuries – FT Alphaville