Despite PIIGS, Rates Rise On QE2 Plans

Posted by Barry Simson on December 03, 2010

barry_f.jpegThe market often chooses what it wants to look at, which may not be what is expected.  This past month is a good example. 

One of the big events which the market watches is the problem with the PIIGS.  That’s an acronym for the European countries with sizeable debt and deficit positions – Portugal, Italy, Ireland, Greece and Spain.  In particular, Ireland was in the news over the past month.  When there is uncertainty in the euro, U.S. Treasuries usually are the beneficiaries.  In other words, money flows into U.S. Treasuries, causing rates to fall. 

The second and third items are related.  The second item is the Fed announced their second round of Quantitative Easing (QE2).  What this means is the Fed will be in the market for the next 6 to 8 months buying a large amount of various securities.  The addition of a large buyer like the Fed means that more money will be trying to buy U.S. Treasury securities and theoretically rates should remain the same or fall. 

However, the third piece of news was that economic statistics showed that the economy may be slightly stronger than they had shown earlier in the year.  There was some positive news on unemployment claims, retail spending and consumer confidence.  These statistics came out just as the Fed was announcing its QE2 to help the economy grow.  A stronger economy with more stimulus from the Fed and the Fed talking about wanting inflation to move a little higher caused interest rates to rise over the course of the month despite efforts to make them lower.               

Despite two events which should have pushed rates down over the past month, rates have risen.  Two year note yields increased from 0.38% up to 0.54%.  Ten year treasury yields increased 45 basis points up to 2.96%. 

For municipal securities, there is uncertainty this year end as the TARP program winds down which authorized Build America Bonds and changed the maximum amounts on Bank Qualified bonds.  The yield on a generic two year municipal bond increased by just 0.02% to 0.54%.  The yield on a ten year municipal security increased about 19 basis points to 2.78%.