The Great Debate

– John Kemp is a Reuters columnist. The views expressed are his own –

The bond market’s adverse reaction after the Fed announced no new asset purchase facilities or bond buyback programs highlights the fundamental difference between interest rates and quantitative easing (QE).

Rate cuts provide ongoing support for an indefinite period until the Federal Open Market Committee chooses to reverse them. In contrast, QE programs provide a one-off, time-limited boost that has to be continually reapplied to have the same effect.

With interest rates a decision to leave rates alone represents “no change” in policy; with QE, a decision to leave the scale and duration of the buyback program unchanged is a “tightening”.

QE is time-limited because it drives up bond prices and cuts yields only as long as buybacks continue, or are expected to do so. Once planned buybacks have been completed, or are not expected to be extended, the market will revert to its natural clearing equilibrium. Repeated doses of QE are needed just to keep yields unchanged.

– John Kemp is a Reuters columnist. The opinions expressed are his own –

Yields on long-term U.S. Treasury debt continued to surge higher yesterday as the market braced for a future upturn in inflation and a tidal wave of long-dated issues that will be needed to fund the bank rescues and the emerging stimulus package.

Yields on three-year notes are up by around 47 basis points from their mid-December low. But yields on ten-year paper have soared 82 points and rates on the 30-year long bond have surged 114 points. Long-bond rates have retraced more than half their decline since the autumn (https://customers.reuters.com/d/graphics/USTREAS.pdf).

Back-end yields would probably have risen even further were it not for persistent hints the Federal Reserve is thinking about buying longer-dated issues to cap them. But the market has started to call the Fed’s bluff.