History of QE

The market obviously was excited today to hear the F_O_M_C had decided to engage in open-ended QE3. First what is QE? Is there distinctions in QE?

This is a look at the different versions of F_O_M_C "Unconventional policy". I'm not trying to make any definitive statements, but if examined closely, there are some relevant questions as it related to matters important to trading. While dollar debasement by way of printing is broadly inflationary, it has been shown to effect different asset classes in different ways. Whether F_O-M_C policy actions are effective or not is not part of this look at actions.

There have been interesting questions raised about today's policy action such as, "Has the F_E_D removed one of its more effective tools, uncertainty?" as shown by a graph of the S&P-500 that comes from a New York F_E_D report.

Another question is how sensitive is the corporate/manufacturing margin squeeze to inflation at this point in time with last week's US Manufacturing ISM "Input Cost" sub-index rising and how will that effect perception of F_E_D policy.

As noted earlier today, at exactly 2:27 nearly every asset class topped when Ben said the F_E_D would make adjustments to QE-3 if inflation becomes troublesome and possibly revealing the limit to F_E_D capabilities?

Has the market already discounted (priced in) QE-3?

Almost every previous policy action had not been priced in except the 2010 QE-2 which had been telegraphed by Bernanke at his Jackson Hole, WY speech a few months earlier?

As well as a number of other smaller peculiarities today (although I wouldn't read much in to events that may be a little strange based on 4 hours of trade).

The bottom line is we'll look at the data and see if there is sufficient evidence to draw conclusions, whatever they may be. We are most definitely in one of the most unique times in market history

First though, what actually is Quantitative Easing?

Quantitative Easing is "unconventional" Central Bank monetary policy used to stimulate a nation's economy when conventional monetary policy has become ineffective. For traders who have been around for a while before the 2008 crisis, you may remember huge swings in the market based on tightening or loosening of interest rates such as the F_E_D Funds Rate, which has been near zero (ZIRP-Zero Interest Rate Policy) since December 16th of 2008. As even as conventional tools such as interest rates have been used in an unconventional way (ZIRP), it has proved ineffective in stimulating the economy.

Quantitative Easing is used to buy assets and injects money in to the economy, primarily in to those institutions in which assets are purchased-typically banks.

QE-1

QE-1 began November 25, 2008 with an open-ended program to purchase $600 billion in Mortgage Backed Securities (MBS) with the intention of creating better credit conditions.

By January it is clear the economy isn't doing better, the unemployment rate is rising. On Feb. 13 2009 the Obama administration deploys a $787 bn dollar stimulus package, "The American Recovery and Investment Act of 2009". By March 9th, the SPX has lost over -21% since QE1 began.

March 18th the F_E_D increases QE1 with another $100 bn in Agency-Backed MBS purchases ($750 bn total) and for the first time adds $300 bn in longer dated Treasury purchases to be carried out over 6 months.

QE-1 ends, the SPX is up nearly 73% off the March 2009 lows.

Since the addition of the purchase of up to $300 bn in Treasuries is added to QE1 until the end, TLT (20+ year Treasury ETF) loses -14.25%  By November 6th 2009 unemployment is over 10%.

With no successor program announced, the S&P is near a top gaining approximately 4% since the end of QE-1.

March 31, 2010


The 30 year fixed mortgage rate dropped from 6.33% at 11/19/2008 to a low of 5% during QE-1 and ended QE1 at 5.23%. Experts predicted rates on 30 year fixed mortgages to rise after QE-1 ends, but to their surprise 30 year rates continue to decline, on 4/7/2010 rates were 5.4% and declined to 4.5% by 9/22/2010.

The S&P's initial drop of over 21% during the first stage of QE1 suggests the addition of long dated Treasury purchases (as declining treasury prices would force investors to look elsewhere for gains) in March of 2009 may have been part of what drove gains in stocks although we can't dismiss the addition of Government Stimulus and additional MBS purchases.

QE-2

After the S&P falls 16% from the April 2010 highs, on 8/27/2010 Ben telegraphs QE-2 at a speech given at Jackson Hole, WY.

At the F_O_M_C meeting on 11/3/2010, after noting high unemployment, lower housing wealth, tight credit conditions, a decline in business spending, weak investment in non-residential structures, employers' reluctance to hire, and depressed Housing Starts; Ben also notes long term inflation expectations remain stable and recent inflation data over the last several quarters had been trending lower ; the F_O_M_C will maintain its existing policy of re-investing principal payments from its security holdings and in addition will purchase an additional $600 billion in long term Treasuries at the pace of $75 bn a month with Permanent Open Market Operations to be carried out by the New York F_E_D's trading desk.

 You may recall these purchase dates called "POMO" and how almost immediately after completing an operation by purchasing Treasuries from Primary Dealers like Goldman Sachs or the now defunct MF Global (approximately 42 Primary Dealers/Investment Banks  in all), within about an hour the market would surge higher as the Primary Dealers flipped Treasuries to the F_E_D, which in some cases were held for less than a week for billions in profits for the PD's. The nearly risk free profits went directly in to risk assets including stocks (mostly momentum and heavily weighted stocks within an Index) as well as Precious Metals and Commodities.

This time mortgage rates rose, note this was a Treasury only program, there were no MBS securities bought.

QE-2 which was not open-ended like QE-1, had its completion date telegraphed as it began and ended June 30th 2011.

A)Ben telegraphs QE-2 at Jackson Hole on 8/27/2010 ; B) QE-2 starts 11/3/2010 with $600 Billion in slated long term Treasury purchases; C) QE-2 ends June 30th 2011. A week later on July 7th the S&P makes its final post QE-2 high (+2.47%) and drops -19% in to early August.

Treasuries/TLT performance from the Jackson Hole speech to the end of QE-2

Long term treasuries targeted for purchase by the F_E_D started selling off immediately after the Jackson Hole Speech, the market was "Front-running" the F_E_D. Unlike QE-1 which was open-ended, QE-2 had a definitive end date and this Treasuries and stocks were also front run before the completion of QE-2.

Operation Twist

Twist was widely anticipated, perhaps we can thank the WSJ's Hilsenrath?

On September 21, 2011 the F_O_M_C noted deterioration since the August meeting including slow economic growth, weak labor market conditions, an elevated unemployment rate, investment in non-residential structures was still weak and the Housing Sector remained depressed. On the bright side, business investment in equipment and software was expanding, inflation had moderated from earlier in the year as energy and commodities had declined from their peaks (a direct result of QE-2)- they also noted that longer term inflation expectations remained stable.

The F_O_M_C went on to announce they would buy $400 billion in Treasuries with a maturity between 6 and 30 years and sell bonds with a maturity of less than 3 years, thereby extending the average maturity of the F_E_D's portfolio. Twist is similar to what the ECB talked about in their own bond-buying (OMT) program announced last week, it attempts to get the effect of Quantitative Easing, but does so by sterilizing the purchases by selling an equal amount of (in this case short dated bonds) other assets in the portfolio, thereby requiring no new printing of money and keeping their balance sheet from expanding. The intent is to keep inflation from rising which is a direct effect of QE.

This is 100% inflation in a broad commodity index, certain commodities gained significantly more and Corporate profit margins were shrining as a direct effect of higher input costs. Last week we saw Global manufacturing data with the 16 biggest developed economies that had reported all showing manufacturing contraction and 80% of the world's economies in manufacturing contraction. New orders and exports were in contraction, inventories were up and despite what might be termed, "Stable inflationary outlook", the sub-index for US manufacturing covering material/input costs, was rising, You probably don't need me to spell it out, but manufacturing the world over is in contraction with exports falling, new business falling, stock/inventory rising and in this harsh climate, input costs as of last week's release, were rising. After 2 rounds of QE, corporations were feeling the pinch of a margin squeeze on earnings due in large part to inflationary pressures created by QE, thus operation Twist.

 Above: A) QE-2,  B) QE-2 ends, C) September 21st Operation Twist announced, D) European banks ae ordered to raise capital ratios, with depressed stock prices they chose not to issue new shares and instead sell U.S. Dollar denominated holdings like PrimeX (Prime Mortgages) which saw so much selling they fell below par for the first time in history, the $USDs were sold, Euros (seen in white) were bought so the money could be repatriated, this put downward pressure on the $USD and upward pressure on stocks as the correlation between a weak $USD/cheap stock prices spurred the legacy arbitrage trade; E) Operations Twist-2 (Twist extension).


Long datedTreasuries-TLT A) QE-2 ends and treasuries rally, B) Operation Twist announced, C) Twist extended.

Operation Twist 2

June 20th 2012 the F_O_M_C announces the extension of Twist with an additional $267 billion in 6+ year Treasury purchases (same conditions as Twist 1), extending Twist through the remainder of 2012. Additionally the F_O_M_C continued the ongoing policy of re-invsting payments related to it's holdings of Agency debt and Mortgage Backed Securities (MBS).