Monetary stimulus begun to fade

The reaction to the monetary "stimulus" provided by the FOMC and the BoJ over the past week has begun to fade and will continue to do so. And whilst some continue to say that the ECB has provided additional stimulus, I will point out that they haven't bought a single bond of any country under the newly announced OMT plan and have not actually announced any plans to do so.

So after the sell-off in government bond markets, the past few days has seen a recovery in bond markets and 10yr US Treasury yields are now back at 1.72%, the same yield as just before the QEP announcement.

One consequence of the policies from the FOMC is to have risen inflation expectations and not just in the US. But the past days have seen declines in front end inflation expectations and that is gradually feeding through into longer dated expectations as well. Whilst the US saw the largest rise, the UK also saw a significant rise in 10yr inflation breakevens. However that is starting to subside as well now as commodity prices are falling.

Chinese PMI data this morning has led to further falls in commodities today. Chinese PMI remains below 50 and signals further slowing in the Chinese GDP data. Copper is down nearly 2% so far and Oil is continuing to slide and WTI is now down 7% from the post QEP euphoria.

So that looks likely to feed through into Inflation expectations especially in the US.  If Copper follows the declines in Oil, it shouldn't be long before the 5yr US inflation breakeven is back below 2% again.

But the major consequence of QEP has been to see the relationship between 5yr 5yr Forward inflation expectations widen to the US Treasury forward curve. If QEP hadn't been announced then the rise in inflation expectations would have justified a yield  of above 2% for the 10yr US Treasury. But as commodities fall the rise in inflation expectations should be reversed and this should see 10yr yields fall from here as well.

There has been a decline in US Swaps Implied Interest Rate Volatility. This has been supportive to risk markets but it still remains at elevated levels. It continues to be better value in selling interest rate volatility than it is buying credit.

So even after the recent volatility in fixed income markets- we are back to where we were a week ago in the US. Given that the Central Banks of the world have now thrown everything at the markets we should see the economic data now take centre stage and that is not improving. Of course there will be some that will argue that the data will bounce back once the stimulus takes affect, but there has been little proof that the previous QE did too much lasting good, so the majority should start to see that Global growth is weakening further.

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