Fed May Buy $300 Billion in Treasuries After QE2
By Daniel Kruger and John Detrixhe - Jun 27, 2011 7:15 AM ET
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The U.S. Federal Reserve building stands in Washington, D.C., U.S. Photographer: Joshua Roberts/Bloomberg
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June 24 (Bloomberg) -- Michael Cloherty, head of U.S. interest rate strategy at Royal Bank of Canada’s RBC Capital Markets unit, talks about Federal Reserve monetary policy, U.S. Treasury yields and investment strategy for savers. Cloherty, speaking with Tom Keene on Bloomberg Television's "Surveillance Midday," also discusses the U.S. economy, oil prices and the European debt crisis. (Source: Bloomberg)
The Federal Reserve will remain the biggest buyer of Treasuries, even after the second round of quantitative easing ends this week, as the central bank uses its $2.86 trillion balance sheet to keep interest rates low.
While the $600 billion purchase program, known as QE2, winds down, the Fed said June 22 that it will continue to buy Treasuries with proceeds from the maturing debt it currently owns. That could mean purchases of as much as $300 billion of government debt over the next 12 months without adding money to the financial system.
The central bank, which injected $2.3 trillion into the financial system after the collapse of Lehman Brothers Holdings Inc. in September 2008, will continue buying Treasuries to keep market rates down as the economy slows. The purchases are supporting demand at bond auctions while President Barack Obama and Republicans in Congress struggle to close the gap between federal spending and income by between $2 trillion and $4 trillion.
“I don’t think the Fed wants to remove accommodation in any way, shape or form,” said Matt Toms, the head of U.S. public fixed-income investments at Atlanta-based ING Investment Management, which oversees more than $500 billion. “It’s quite natural for them to reinvest cash,” he said. “That effectively maintains the accommodative stance.”
Mortgage Debt
A total of $112.1 billion of the Fed’s government bond holdings will mature in the next 12 months, 7 percent of the $1.59 trillion in Treasuries held in its system open market account, known to traders as SOMA. Replacing those securities will require the Fed to buy an average of $9.4 billion of Treasuries a month through June 2012.
The Fed also held $914.4 billion of mortgage-backed debt and $118.4 billion of debentures, the debt of government sponsored enterprises Fannie Mae and Freddie Mac, as of June 22. UBS AG, Citigroup Inc., Bank of America Corp., JPMorgan Chase & Co. and Royal Bank of Canada say $10 billion to $16 billion will mature each month, depending on the pace of prepayments.
In a Bloomberg survey of 58 economists June 14-17, 79 percent said Fed Chairman Ben S. Bernanke will sustain the central bank’s balance sheet at current levels until the fourth quarter, compared with 52 percent in April. The Fed said June 22 its goal is to hold assets at $2.654 trillion.
Treasury 10-year yields fell to the lowest since Dec. 1 today, down from this year’s high of 3.77 percent on Feb. 9. On June 24, the two-year yield came within one basis point of the record low, set November 2010, reaching 0.32 percent.
Frustrated Fed
The yield on the benchmark 10-year note declined to 2.84 percent today, the least since Dec. 1, before settling at 2.86 percent. The 3.125 percent security due in May 2021 traded at 102 1/4 at 7:13 a.m. in New York, Bloomberg Bond Trader prices showed. Two-year yields were at 0.34 percent after reaching 0.32 percent last week, the lowest since Nov. 4.
Bernanke said at a press conference June 22 that progress bringing down the 9.1 percent U.S. unemployment rate was “frustratingly slow.”
Fed officials said the economy will expand 2.7 percent to 2.9 percent this year, down from forecasts ranging from 3.1 percent to 3.3 percent in April. It was the second time this year Fed officials lowered growth estimates. Gross domestic product expanded 3.1 percent last year.
Policy makers said they expect the world’s largest economy to grow 3.3 percent to 3.7 percent in 2012, according to their central tendency forecasts. In April, their predictions ranged from 3.5 percent to 4.2 percent.
Fear Factor
Fed officials predict an average unemployment rate of 8.6 percent to 8.9 percent in the final three months of 2011, compared with 8.4 percent to 8.7 percent projected in April. Their estimate for unemployment at the end of 2012 was in a range of 7.8 percent and 8.2 percent, compared with 7.6 percent to 7.9 percent in April.
While the Fed didn’t start a third round of quantitative easing, as some traders speculated was needed, Treasuries could gain on weakening of the economy or the European sovereign debt crisis.
“What always moves the market is fear and greed, and there’s a huge amount of fear on the economy,” said David Brownlee, head of fixed income at Sentinel Asset Management in Montpelier, Vermont, which manages $28 billion. “That’s where you want to have Treasuries.”
The conflict between Obama’s administration and Congress over increasing the government’s borrowing limit could lead to higher yields, as Moody’s Investors Service and Standard & Poor’s said they may consider cutting the nation’s AAA credit rating unless progress is made next month.
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