Fed Asset Purchases Vs. Bond Yields

//research.stlouisfed.org/fred2/graph/graph-landing.php?g=GIm

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.

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

Correlation: 10 Year Bond Yields Vs. Total Public Debt Growth

Azizonomics taught me another correlation. When debt grows faster (red line goes up), normally the treasury yield should go up.

But from year 2000 onwards it didn’t happen. Either the treasury yields should go up, or the debt growth should slow down.

Chart 1: Federal Debt Growth Vs. 10 Year Bond Yields

Scott Minerd: The Faustian Bargain

To add more credence to the importance of interest rates on the assets of the federal reserve (and the banks) I will point to this article of Scott Minerd: The Faustian Bargain.

He says that it only takes a rise of 1% in interest rates to render the fed insolvent.

“Now, a 100 basis-point increase in interest rates would cause the market value of the Federal Reserve’s assets to fall by about 8% or approximately $200 billion which would leave the Federal Reserve with a capital deficit of $150 billion, rendering it insolvent under Generally Accepted Accounting Principles (GAAP).”

So I wasn’t talking BS when I said interest rates are very important for the assets of the federal reserve and the bank’s balance sheet. When interest rates rise, bad things happen.

Another thing to point out is that during high inflation (Table 1: purple blocks), bonds are the worst investment as bonds won’t act well in inflationary times. Farmland, gold and silver on the other hand are good performers. And as Marc Faber always points out, art and collectibles will do especially well.

Chart 1: Outperformance comparison (art, stocks, farmland, gold, silver, bonds)