April 19, 2011
QE1 was announced (the first red arrow on the left) amid and because of a global banking panic, Gundlach said. The result was a continued decline in rates that ended in December of 2008.
When the purchases actually began, though, bond yields started to rise. That was counterintuitive, Gundlach said, because government’s buying actions should have pushed prices up and yields down. His explanation was that bond investors get nervous when there is a strong inflationary-biased policy. While government buying supported the prices of newly issued securities, investors holding the other $8 trillion of Treasury bonds were unsettled and pushed yields on the 10-year from 2% to 4%.
When QE1 was extended, yields rose even further.
On March 31, 2010, purchases from QE1 ended and bond yields collapsed. Gundlach said this was probably because the stimulus that quantitative easing represented was withdrawn, and that hurt the economy. The withdrawal of QE1 may have also made bond investors feel better that inflationary policies were no longer being pursued.
“The implementation of quantitative easing has produced exactly the opposite market behavior that some people intuitively expected,” he said.
When QE2 was announced, yields bottomed, and when bond purchases began, yields rose.
“The idea that ending QE2 would necessarily mean a rate rise flies in the face of the bloodless verdict of the market,” he said, “which is that when quantitative easing was in place, bond yields rose, and when it was taken off it led to weaker economy and rates falling. I think that is going to happen again.”
Gundlach also said that the start of QE1 triggered a rally in equities, and that rally was amplified when QE1 was extended. When QE1 ended, stocks fell. Stocks rallied again when Bernanke made his speech in Jackson Hole announcing QE2 and rallied again when the buying program began. Gundlach said he expects that pattern to repeat, and that stocks will go down when QE2 ends. “The discounting for that should be starting in the relatively near term,” he said.
Gross has not spoken publicly about his decision to short the Treasury market. But in his last monthly commentary, he offered the likely explanation – his disgust with Congress’ inability to address its debt burden and, in particular, federal entitlement programs. He wrote that the inevitable outcome would be higher inflation or its equivalent, a declining dollar.
Gross also wrote that the government could manage its debt “stealthily via policy rates and Treasury yields far below historical levels – paying savers less on their money and hoping they won’t complain” – and that policy direction supports Gundlach’s position.
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