The Federal Reserve’s Federal Open Markets Committee (FOMC), as anticipated, announced on Wednesday that it would extend the average maturity of its securities holdings. The FOMC stated it would transfer $400 billion worth of its holdings to Treasury securities with maturities from six to 30 years from Treasury securities with maturities less than three years. It will execute this move by June 2012 by buying longer dated debt while selling shorter dated debt.
While the move was anticipated, it was made more controversial after a group of Republican Congressional leaders sent a letter to Federal Reserve Board Chairman Ben Bernanke expressing their reservations over any “additional monetary stimulus proposals.”
Numerous Fed observers viewed the letter as unprecedented and a challenge to the Fed’s independence.
Here is how various markets reacted to the announcement:
The U.S. Dollar Index was perhaps under the most pressure from a potential third round of quantitative easing and had the most to lose as it has risen sharply in September due to Eurozone woes. The reaction indicates some folks may have thought there was a chance for QE3.
Gold initially whipsawed on the news then dropped but did not take out any significant support.
Crude oil, perhaps, gained more than any other other market from QE1 and QE2. It dropped when it was clear there would be no QE3.
The Dow whipsawed on the news and then dropped as the dollar rallied.
The Dow seemed to anticipate the news more than the S&Ps.
Obviously the sector impacted the most was fixed income, specifically U.S. Tresuries. The benchmark 10-year Treasury note futures whipsawed before eventually moving higher. The Fed will be buying more 10-year notes as they lighten up on the short end.
The FOMC move means that the Fed will be lightening up on their holdings in the short end, which is best demonstrated by the reaction in three-month eurodollar futures.
With the Fed buying $400 billion in Treasury securities with remaining maturities of six to 30 years, and selling an equal amount with maturities of less than three years, that leaves the five-year note in limbo. Its reaction to the news reflected this confusion.
The big winner on the day, apart from the dollar, is the former (and given our debt obligation potentially future) champion long bond or 30-year Treasury.
The Fed will execute their plan over the next nine months, which could create some interesting arbitrage and spread trades within the Treasury complex.