House of Debt

Atif Mian and Amir Sufi have started a blog related to their new book, "House of Debt." Amir and Atif are admirably data-oriented, which ought to make for good reading.

Today's post "Fed Meetings and Asset Prices" is a good example. They put together one-day returns on the June 19 "taper tantrum" when the Fed announced it might (heavens) start tapering bond purchases. There is, of course, a large literature studying announcement effects. Atif and Amir  put together an unusually wide spectrum of asset classes.

It's interesting that corporate bonds are most affected. Really, the credit spread widened. It's interesting that the intermediate government bond is hurt more than long and short -- maybe there is something to the idea that the Fed really affects the 10 year maturity where it's doing more buying. It's interesting that banks (financials) are not much affected. (Though be careful, these returns are scaled by volatility.)

My thought: This cross section is most interesting as an illumination of why QE might or might not work. Markets move, but never tell you why they move, and analysts jump too quickly to the conclusion that these reactions measure the direct economic effect of quantitative easing. Here are some theories to distinguish:

  1. QE works directly, by changing the M in MV=PY. The announcement of tapering means there will soon be less M so we should primarily see output and inflation effects. 
  2. QE works by lowering the long-term interest rate via some sort of segmented markets story. Thus, this is news that the yield curve will start to steepen, with no news about the low end
  3. QE is irrelevant per se, the Fed is buying green M&Ms in return for red M&Ms. But we all know that first comes tapering, then comes interest rate hikes, (then comes macroprudential meddling?) So, this is news that the short end of the yield curve will rise sooner than expected, with any long end effects coming from expectations hypothesis logic alone. We update to a higher but flatter yield curve.
  4. QE is completely irrelevant, but announcements reveal the Fed’s analysis of economic activity. The Fed is one of the most thoughtful economic forecasting shops around, with loads of private information, especially about what’s going on at the TBTF banks. If the newspapers had said “Mohamed El-Erian says economy stronger, rates to rise in 14”, markets might well have moved on the news too. 
  5.  QE is completely irrelevant, period. Markets think the Fed matters a lot, but it doesn’t. We’re out of rational expectations equilibria because nobody has seen a $ 3 trillion balance sheet, interest on reserves, and zero rates before. When in 44 AD the high priest of the temple of Jupiter came forth the day following the ides of iulius, to announce that he had spied the pattern in the murmuration of starlings, and that the harvest would taper down this year (I totally made this up), Roman grain futures markets fell. Are we really so much smarter?

I find the cross sectional results most interesting in how they might help us sort these stories out. Amir and Atif speculate a bit about what it means, and promise more in future posts. Worth watching.

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