donderdag 31 juli 2014

Fed Asset Purchases Vs. Bond Yields


How counter intuitive it may seem, when the Federal Reserve tapers (reduces asset purchases of bonds and mortgages), the bonds actually go up instead of down. This article explains it clearly. So you can predict what bond yields will do by listening to the asset purchase plans of the Federal Reserve. Then profit on it.

The obvious reason is that reduction of QE is good for the dollar (and good for bonds), while QE is bad for the dollar because it generates inflation concerns (hence bad for bonds). So QE will send bond yields higher because of inflation concerns, while reducing QE will send bond yields lower.

The second reason is that all of the money printing goes into capital goods like stocks. When QE ends, stocks will drop and that money goes back into bonds.

The third reason why central bank asset purchases coincide with higher bond yields is because the central bank usually acts when bond yields are going higher. The chart below shows that the Fed started buying bonds when bond yields went higher (in order to push yields down). Once yields are normalized again, the central bank stops its purchases.


Conclusion: Expanding Fed balance sheet coincides with higher bond yields and vice versa.

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