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ugh. If I borrow overnight and lend you for 4 weeks, that is exactly PEH. Sorry, I was wrong. Not even going to think about the other direction now.

"Yep. That's the exact case of helicopter money. It's what Australia did. But you can't subsequently reverse it, if you need to, without tax increases."

Sure you can, you can cut fiscal expenditures below a net of 0 and just delete the extra money.

FOMC QE2 statement is out.  Worth analyzing a bit.  Here's the part that's most relevant to this post:

"The Desk plans to distribute these purchases across the following eight maturity sectors based on the approximate weights below:  Nominal Coupon Securities by Maturity Range: 1 ½ to 2 ½ years: 5% 2 ½ to 4 years: 20% 4 to 5 ½ years: 20% 5 ½ to 7 years: 23% 7 to 10 years: 23% 10 to 17 years: 2% 17 to 30 years: 4% (The on-the-run 7-year note will be considered part of the 5 ½- to 7-year sector, and the on-the-run 10-year note will be considered part of the 7- to 10-year sector."

It's roughly equally distributed from 2.5 to 7 years.  Half as dense between 7 and 10 years, and almost nothing under 2.5 or longer than 10 years.  It's longer than I expected (I thought maybe 3-4 years for starters).  But if we ignore the part of the curve that they can't effect anyways (since it's already near zero) it's definitely skewed towards the shorter end of the curve.  And, to me, it looks like its having a (very small) effect in the intended direction.  On the announcement:  2 yr and 10 yr rates roughly unchanged.  5 year 7 bps tighter, and 30 year 8 bps wider. I.e. steepening from 5 to 30, cheapening the cost of funding for almost all purposes (less than 10 years is almost everything) and threatening inflation in the longer part of the curve.  So coherent practical and communication effects. 

On another note, by announcing exactly what they intend to do over the next 8 months, they just got front run.  You can't run a profitable trading strategy of that size in public.

K: Thanks for posting that.

Presumably, they wanted to be "front run". So the consequences start now (or rather, started when they first intimated they might do it).

You take the *steepening* of the yield curve, as opposed to the absolute level of yields, as evidence of the success of the strategy? The less than 10 years is where the actions are taking effect, and the greater than 10 years is where the communications strategy is taking effect?


Yes, that's how I was thinking about it.  Though it's the 10 yr yield that's unchanged.  In terms forward rates, I haven't checked, but I would guess the forward curve (which is more like a short rate forecast) starts widening well before 10 years (6-7 years maybe?). 

Of course, it's both the steepening as well as the absolute move that's relevant.  But, for the most part, the overall size of the program appears to have been anticipated.  All we can really say from today's move is that the market appears to have been surprised that the duration of the purchases is going to be as short as they've announced.  Maybe that means that compared to the market, the Fed is leaning towards the perspective that it's best to principally manipulate the front end of the curve, and leave the market to handle the rest.  As I've said, I think that would be a sensible strategy, but 15 bps of steepening isn't huge evidence of anything.



Forward rates are implied and thus are nothing but pure speculation. They are useless for predicting short much less long rates. As the quantiest of quanty eared folks, Paul Wilmott, put it, assuming that interest rates follow forward rates is financial suicide.

vjk: Are you still on about the EH? I thought we were done with that.

Not at all.

Rather about predicting future with forward rates.

Although, I am sure, there was someone who tried to use forward rates to "prove" EH.

But forwards being the expectation of the short rate *is* the PEH.

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