End of QEII Fast Approaching

According to the Fed, QEII will be ending as of June 30th.  The programs the Fed has put in place to stimulate the economy have been nothing short of monumental and QEII is no exception.  Since the beginning of 2008, the Fed has increased their balance sheet from approximately $800 billion to now close to $3 trillion.  Much of this has been through quantitative easing programs and specifically the purchases of various types of securities, mainly Treasuries. PIMCO's Tony Crescenzi gives a great anology for the recent easing program:

"Picture a store today where a few customers are inside waiting for new wares. A truck is outside – it’s the Treasury truck, and it is back again to unload a fresh supply of Treasuries to refill the store’s emptied shelves. The store’s biggest customer, the Fed, quickly grabs about 70% of the supply. The remaining buyers compete for the scraps that are left.

Mind you, the store’s biggest customer before the Fed entered the store was the rest of the world – the world’s central banks, that is. They tend to purchase about 50% of what the Treasury truck delivers, and their demand is fairly constant owing to the large amount of dollar reserves they accumulate as a result of global trade. There are other fairly consistent buyers, including pension funds, insurance companies, and commercial banks, which collectively own close to 15% of Treasuries. Doing the math, it is easy to see why the remaining buyers have been willing to pay up to own Treasuries – the Fed’s ultralow rate policy has left them with slim pickings worse than the scramble by people piling into a Wal-Mart on Black Friday at 3 a.m. to fill up their carts before others do.

Fast forward to 1 July. The biggest customer with the fattest wallet leaves the store. There is a modest “flow” effect, but prices aren’t immediately affected, because the “stock” effect is still very present, with the Fed having cleaned out most of the goods. The remaining buyers therefore dash to the shelves and scurry to buy whatever the Treasury truck delivers. As the days pass, the Treasury truck keeps on backing into the store to deliver a fresh supply of Treasuries as it must because with a $1.4 trillion budget deficit,  there are a lot of Treasuries to unload. Soon enough, the shelves fill up and the stock effect becomes a negative for prices, all else equal of course, and so long as that biggest customer stays out of the store."

It will be interesting to see what happens after July 1.  While we don't anticipate a huge move in yields immediately, due to the effect of an extremely low Fed Funds Rate, we do anticipate volatility.