Tuesday, May 17, 2011

Nomura's Richard Koo - Great thoughts on QE

Nomura's Richard Koo comes in explaining QE, its goals, its current achievements and the impact in certain asset classes.
I found this report to be very interesting and straight forward.

The one point that Mr. Koo didn't speak about explicitly is the 2nd-round effects of QE: sov bond crowding.

He pointed out nicely what Berna-man wanted to achieve: make bond prices go up (yields down) and thus providing stimulus and apettite for other asset prices increases.

This 2nd round effect would be, in my opinion, that those people not interested in bonds because the Fed has been bidding them all up would funel their capital into other asset classes. So imagine that the US has a 1.4USD trillion deficit. And the Fed is buying 600USD billion. So some of those bond buyers that do not want bonds now at current yields (heard of PIMCO? Moustached El-Erian? William Gross?) will have to buy other assets or leave their capital into cash.

So 2 things:
- I believe QE2 effects the economy as long as asset prices keep RISING. If they STOP rising the impact it has in growth dimishes.
- When QE2 ends I find it unlikely that risk markets will remain solidly going up. Then economic data will come down and risky asset prices will actually respond to this data coming down too. And the cycle starts over.

What would you add/subtract from my analysis?

I try to think of everything in terms of supply-and-demand.

Consider that the banks which sell US Treasuries to the Fed keep their cash in hand, not able to lend it.
Consider investors that sell the same USTs to the Fed.

Now the supply of USTs has dimished. The Fed owns a lot of it and won't float it to the markets.
Lower supply, higher prices (lower yields).
The banks, supported by the "extended period" language printed on the FOMC Minutes, will be comfortable to buy other treasuries, thus reducing USTs supply further and lowering yields further.

Consider ZIRP at the short-end of the USD bond curve.

Now the investors have cash in hand. And they have low yields.
Retired people have maturing bonds, cash in hands. And they hate low yields.

That is all demand = cash available.

Now these investors will have to seek investments for the cash they got.
They either go further out the yield curve (more risk, more yield) or they chase other assets.

That's QE. People got nothing to do with their money.... and they forget the reason why yields are low: economic slowdown, high leverage throughout the economic system.

These reasons mean there's RISK out there. But they deny it. They don't visualize it.

And they're in great danger in case QE ends and the economies don't grow.

2011 05 17 - Nomura - Richard Koo - QE2 Has Transformed Commodity Markets Into Liquidity-driven Markets

*Disclaimer: charts and data are presented as I receive/see them. Sources are usually not checked for validation and my own calculations are of 'back of the envelope'-type. I am aware that some math that I do myself might be wrong and/or misleading to some extent. In financial markets the rate of change of economic data is often more important than the actual level and the perception of 'what is priced in' is more important than 'what is actually going to happen'. This is actually the way people pick entry and exit points. So... yes, sometimes you might say 'This guy is an idiot, this is way wrong!' with a high conviction, being right. Not to worry. Markets are made of expectations and the clash of conviction between its participants. Portfolio managers know that being an idiot is sometimes profitable and being smart is often a bad choice. It is all reality, sometimes good, sometimes bad. By the way: corrections to my analysis and intelligent debate is welcome. theintriguedtrader AT gmail do com

No comments:

Post a Comment