FT Alphaville " Will rates stay low, QE or no? It was inevitable that the abysmal payrolls report last Friday would make louder the calls for another round of quantitative easing from the FOMC, which meets later this month. QE can take various shapes, but we wanted to mention something about the specific idea of the Fed buying up more US Treasuries: as a few analysts have pointed out recently, there's a pretty good chance that rates will stay low no matter what the Fed does. Since the first round of QE, the composition and size of the Fed's balance sheet has changed dramatically. It now owns a big part of outstanding US Treasuries (chart via Deutsche Bank): Torsten Slok of Deutsche Bank writes: In addition, central banks (Fed, ECB, BoE, BoJ) buying government bonds has lowered supply of risk-free bonds real money managers can buy (for example, the Fed currently holds 30% of all 5-10 year US Treasuries outstanding). Bottom line: More demand for risk-free assets and less supply of risk-free assets combined with significant long-term risks to global growth imply that interest rates are likely to stay low for many more years. All part of the ongoing global safe asset grab. Ten-year US Treasuries now yield about 1.5 per cent, as they remain one of the true stores of value alongside Bunds, JGBs, Gilts, Scandi and Swiss paper. And from JP Morgan's Flows and Liquidity team on Friday, we have five reasons, other than quantitative easing, why rates will stay down for the foreseeable future: Regulations such as Solvency II, pension fund regulations, Basel III It is not only regulations inducing financial institutions to buy bonds, demographics may also be playing a part Due to ultra low policy rates, retail investors replaced money market funds with bonds as savings vehicle G4 central bank QE An acceleration of the global savings glut since the Lehman crisis. The end of the equity culture As you can see in this chart from Bianco Research (via Barry Ritholtz), demand is high without intervention: Of course, QE isn't only about the asset purchases themselves. It's meant to signal the Fed's commitment to doing what is necessary to combat disinflationary pressures and boosting employment. But if quantitative easing is done without any kind of sterilisation (and despite early reports, it now seems that sterilisation is not under serious consideration), it might create problems for Money Market Funds and other parts of the shadow banking system that are competing for the small pool of available collateral. We say "might" because much depends on other factors. Just something to keep in mind if the likelihood is that rates will be low anyways, especially given that the Fed's new communications efforts this year have been somewhat muddled. In that sense, we would emphasize that another round of quantitative easing is, in fact, not risk-free. Related links: The US Treasury market is not enough - FT Alphaville (2010) SOMA helluva change at the New York Fed - FT Alphaville (2011) What the Fed can't buy - FT Alphaville The AAA bubble - FT Alphaville This entry was posted by Simon Hinrichsen on Monday, June 4th, 2012 at 20:17 and is filed under Capital markets. Tagged with federal reserve, Money market funds, Operation Twist, quantitative easing, US Treasuries.