The Federal Reserve's recently launched asset purchase program is making the market nervous.
Investors are concerned that the recent Fed move could make the weak dollar even weaker and lead to trade disputes with other countries who don't want to see their currencies or investments decrease in value. It could, experts said, lead to higher inflation.
According to numbers reported by Braver Stern Securities, QE2 has already had an impact on the forward Libor curves with the two- to three-year portion of the curve up 50 basis points on higher inflation fears (EDZ2 98.56 vs. 99.10).
While many investors do not expect to see a rise in spot Libor in the near term (most projections show a rise in rates in 2012 at the earliest), this rise in the forward curves will have an impact on OAS valuations.
Scott Buchta, managing director and the head of investment strategy at Braver Stern, said that derivatives may be negatively impacted by rising forward Libor curves.
"While very few investors look for the spot rates to move higher in the near future, a steepening of the forward curves will have an impact on OAS valuations and the projected yields of deeply discounted Libor floaters," he noted. "A potential rise in the forward curves may have an impact on both security valuations and hedging strategies. [Public-Private Investment Program (PPIP)] managers in particular may begin to hedge their exposure to rising rates as their future performance may be negatively impacted by a rise in their funding costs."
The biggest problem with QE2 is that the program is perceived as more powerful than it will most likely be, said Joe Mason, a professor of finance at Louisiana State University.
"I have long argued that if money markets are in disequilibrium, simple solutions may not work (and if they do, it may be for the wrong reasons)," Mason said in a note published today. "Without a Fed Funds rate (or other intermediate) target, monetary policy is rudderless. Hence, it is important to help smooth world economic undercurrents to help keep the economic ship away from more rocks."
According to Buchta, the Treasury, equity and credit markets have all sold of on profit-taking and this has renewed fears regarding Europe and the G20 meetings.
"The two-year Treasury moved up to 0.51%, up from 0.31% on 11/4," he said. The 10-year Treasury moved to 2.79% for the first time since Sept 10, he added. Meanwhile, CMBS spreads gapped 20 basis points wider and non-agency RMBS spreads stayed the same to slightly higher on limited trading. The Dec 1012 Eurodollar future has moved 50 basis points lower in price since Nov. 4, Buchta said.
