The Great QE2 Flush Out

We’ve updated our Treasury flow charts with new data from today’s release of the Federal Reserve’s Flow of Funds Accounts. The quarterly data are seasonally adjusted and annualized. They reveal quite an interesting picture.

In Q1 2011, the Fed’s QE2 purchases of Treasuries totaled $1.3 TN on a seasonally adjusted annual basis. This number far exceeds the QE2 total program and is one of the reasons why we tend to discount government statistics which have been seasonally adjusted, annualized, and sliced and diced eight ways to Sunday. It’s all we have to work with, however.

Rather than obsessing over absolute numbers, we focus on the relative movements and flows which are quite revealing. The Fed’s QE2 program has been quite successful in flushing households and nonprofits out of their Treasury holdings into asset classes such as mutual funds (see table F.100).

It’s also interesting that foreign flows into Treasuries has declined significantly since the start of QE2 and as a proportional source of financing for the U.S. budget deficit is at one of the lowest levels in years. Though the Fed will continue buying Treasuries with the proceeds from maturing securities — which we estimate to be around $230.4 BN from July1, 2011 to December 2012 — the end of QE2 will be a big test for the markets.

Unless credit markets begin to recover in a significant way, the source of new liquidity to drive major markets is in question, in our opinion. Flows into one market — whether it be equities, bonds, commodities, or foreign assets — will likely be at the expense at another and follow a zero-sum game.

The trick now for traders and investors will be to try and get ahead of the reallocation and determine which market gets sold and which receive the proceeds. Our best guess (and that’s all it is) is the first post QE2 trade will be commodities and Treasuries get sold and high quality/strong balance sheet corporate equities and bonds are bought. It’s about to get very interesting. Stay tuned.


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