Monday, November 22, 2010

The Markets Give QE2 the Bronx Cheer


Ever since the Fed announced its second round of quantitative easing (aka QE2) it has been subjected to pretty severe criticism from a number of sources.

Politicians, of course, will use any excuse to rail against the central bank (all the while hoping that they succeed) but numerous economists and academics have also come out against the plan.

I don't know whether QE2 will work, but I would agree that that the recent sell-offs in the stock and bond markets have been directly related to the negative chorus. Here's a short piece from today's Wall Street Journal:

Criticism of the Federal Reserve's latest bond-buying program, both from insiders and from U.S. politicians, is muting the plan's potential benefits for the economy.

Amid widely publicized skepticism about the efficacy and wisdom of the bond buying, investors and traders are questioning whether the Fed would be able to expand its bond purchases beyond $600 billion—even if inflation continues falling and unemployment remains high. Those doubts have contributed to an increase in yields on U.S. Treasury bonds since the Fed announced the program on Nov. 3, they say.

Criticism Hinders Fed's Easing Plan - WSJ.com

I continue to believe the sell-off has presented an opportunity for bond investors to extend maturities and add yield to portfolios.

Regardless of whether the Fed's initiative is effective or not, I think it is almost a certainty that short term interest rates will remain near 0% for most of 2011, at the very least, which puts an anchor on the overall bond market.

I also think that municipal bond investors should view the recent weakness in the muni market as an opportunity as well.

The muni market has been overwhelmed by a huge wave of new issues (both traditional muni issues as well as Build America Bonds) at a time when muni demand has slackened. Whenever you see AAA-rated muni bond yields higher than Treasurys, in my opinion, this is the time to buy, not sell, regardless of whatever concerns you might have on muni credit worthiness.