Secondly, the commonly accepted belief is that when the Fed is buying bonds, yields go down, and when they stop buying bonds, yields go up. But even a cursory examination of Treasury yields surrounding the first two quantitative easing programs reveals that the opposite may in fact be true. Chart 2 illustrates that in both cases Treasuries saw significant drops in yield in the months following the end of previous QE programs. This may not, however, provide a clear roadmap with which to navigate the termination of the current program.
The previous two QE programs had defined ending dates, unlike QE3, for which the end is discretionary and intended to be based on improving economic fundamentals, and therefore can be viewed as more of a signal to the market that the Fed is shifting to a slightly less dovish stance. Indeed, any lessons we may take from history could be misleading, as balance sheet expansion of this magnitude is unprecedented.
The selloff in U.S. Treasuries reflects an optimistic market that has grown complacent with regards to risk. Sensitivity to economic results should be high over the summer months, as Fed tapering will likely be announced only after an FOMC meeting and press conference, providing Fed Governor Ben Bernanke the opportunity to thoroughly explain the shift in policy. That could happen in September or December of this year.
In the meantime, we maintain our long bias, again favoring longer-dated maturities.