As expected, because the Fed’s QE pump is still running, the S&P500 managed to grind higher in the face of another round of bad news, domestically and internationally. Volatility, perhaps because it’s nearly as low as it ever goes, crept up slightly. Volume was light, as usual for weeks when prices grind higher because of Fed money printing.
More signs of economic slowdown emerged last week. New home sales for March were the lowest on record for the month of March. The Case-Shiller index of home prices came in worse than expected, which once again confirmed that the housing market is in full double dip mode. Although headline durable goods were better than expected, the ex-transportation number was below. Initial jobless claims have now made a decisive turn for the worse; they came in much worse than expected at 429,000. The first estimate for 2011’s first quarter GDP growth, at 1.8%, was also worse than expected.
The US economic growth is grinding to a halt. And this is happening DURING the Fed’s second QE monetization program.
Technically, the S&P on a daily basis is as overextended as ever. Bearish divergences are everywhere. On a weekly basis, the picture is also one of an overstretched bullish rally that’s just waiting to snap back down.
Conventional wisdom is arguing that when the Fed winds down its QE2 program in June, the US Treasury market will lose its largest buyer and therefore, Treasury prices must fall and yields rise.
So a lot of traders are setting up for a bearish period in US government paper. In fact, one of the largest bond investors—Bill Gross of PIMCO—has publicly announced that he will not buy Treasuries until after QE2 ends and yields rise.
In the last several weeks, we’ve noted that the last time QE ended, the exact opposite happened—instead of yields rising, yields fell. So we argued that something similar may also happen after QE2 ends.
The question, however, still remains: WHO will do all the buying of US Treasuries.
Well, the buyers could be the same investors who’ve benefited from the massive Fed easing program over the last six months.
These investors have sold much of their Treasuries to the Fed (and Fed backed dealers) and rotated their capital into stocks, bonds, and commodities. And these Risk-On assets have—over these last six months—risen tremendously in value, generating trillions of dollars in new wealth for these investors.
How many trillions?
Well, if we consider the stock market alone, using one of the broadest measures (the Wilshire 5000), stockholder wealth has jumped $4.1 trillion since QE2 was pre-announced by Ben Bernanke at the Jackson Hole economic speech in August 2010.
And that’s only the STOCK market!
Imagine how many more trillions of dollars have been created in corporate bonds (investment grade and high yield), in overseas investment gains, and in commodity gains.
Yet the Fed has been printing and buying only about $75 billion of Treasuries per month……..a tiny fraction of all the wealth created over the last six months.
So who’ll buy Treasuries after QE2 ends?
These same investors will. When the liquidity pump stops, and any reasonably meaningful phase of Risk-Off begins, some of this newly created trillions in wealth will rush into the safety of US Treasuries.
Let’s just guess that a total of $7.5 trillion has been created—in total since August 2010 ($4.1 trillion from US stocks and $3.4 trillion from EVERYTHING else).
And let’s just guess that only 10% of this total would rush into Treasuries. That would mean that $750 billion would flow into US government debt markets.
Not only would there be more than enough capital to buy new Treasury issuance for the next six months, but it’s very conceivable that the tsunami of capital (especially if more than 10% rushes in) could shove the yield on US Treasuries DOWN, exactly the opposite of what many experts are calling for later this summer.
In fact, if the Risk-Off phase becomes severe enough, it would not be surprising to see the US 10 year yield drop well below 3.0%, perhaps even below 2.5%.
So THAT’s who could buy US Treasuries. And THAT’s how low yields could fall.