Random thoughts on QE

The second round of Quantitative easing, a fancy name for Fed buying treasuries, is half way through. From the last FOMC minutes, Fed seems to be "satisfied" with the result of QEII so far. It is hard to understand how Fed could be happy with QE II. After 167 billion freshly minted dollars and 69 billion from principal payments on agency debt and MBS are invested in treasuries, yield curve is at its steepest since the great recession started. US economy is not generating anywhere close to the 110k-125k nonfarm jobs that are needed to just keep up with the population growth. Inflation is already showing up at producer level. Inflation is seen in those areas that Fed does not want to see. Cost of living is higher on higher food and energy cost. While disinlfation is seen in the areas which Fed is trying to inflation, such as housing and labor cost. Owner's equivalent rent has been one of the major components that has kept CPI lower. But it has no impact on consumer's cash flow. Fed insisted the low resource utilization rate and sluggish labor market should keep CPI at depressed level, as 70% of the cost of goods are labors. That seems to be right. But it is hard for me to understand how buying US treasuries can turn this vicious cycle around. Company won't hire more people, when there are ample capacity sitting around and they can not pass on higher raw material cost to consumers. Fed maybe is turning a deaf ear to many major US companies last quater's earning. Kraft, Pepsi, P&G and the likes are all reporting lower margin and higher raw material cost. Fed's money printing is going to squeeze the margin of US corporations. Fed can ignore higher PPI and headline CPI for as long as they want, but do they really believe companies will hire more people when they are not able to pass on higher cost?

The only major accomplishment by the QEII is higher equity prices. Fed is trying to cure the hangover by giving the drunk more drinks. Fed cheered that consumer was very strong in the last holiday season. Ironically, it coincided with the first expansion of consumer credit card balance first time after the recession started. Maybe people is borrowing against their paper profit in stock market. It is funny that we got into this recession because inflated housing price cause by the Fed's ultra easy monetary policy, which is used by Fed to pull the economy out of tech bubble, which was again caused by artificially low Fed fund rates help US to recover from the housing bubble in 90s. It seems like the only cure fed has for this alcoholic (or low-rateholic) economy is to have more drinks, so it can pass out and don't have to worry anything before wake up in hangover again. No wonder the Fed fund rate since Paul Volker has been making lower lows during every economic downturn. It was only a matter of time that Fed funds would hit the mighty zero boundary. Now there are QE I and QEII and possibly QEIII, which are designed to mimic a negative interest rate, so savers are punished and spending and leveraging are rewarded.

I don't know how it will end. The bull/bear cycle of interest rate often lasts generation long. People often missed the turn of market and only recognized it long after it happened, as the market tend to anchor its expectation for a "reasonable" range of treasury yield to the recent history. There is only strong meaning reverting mentality among the fix income investors. Market was chasing 2% treasury yield in the 40s after world war II, while 12% in early 80s found no takers. The current bull market for bond has lasted for almost 30 years. Maybe this is going to a starting point of a new bear market for treasuries.