[kublikhan]

$this->bbcode_second_pass_quote('', 'Q')E2 is just about done. But the Federal Reserve will still be buying massive amounts of long-term Treasuries. In fact, the Fed's purchases over the next year will likely be at least $300 billion. That's half the size of QE2 -- even if QE3 never takes place. Think of it as QE2.5.

While the Fed's efforts to pump about $600 billion of new cash into the economy over the last eight months comes to an end this week, the program, known as quantitative easing or QE2 for short, was not the only way the central bank was an active buyer of Treasuries. Since last August, the Fed purchased $250 billion in long-term Treasuries in addition to the QE2 purchases. That's because it was reinvesting the principal from other securities that matured. Assuming the Fed keeps reinvesting, as it said it would earlier this month, it will continue to be a very big buyer of bonds in the months to come.

"We still see the Fed being a major buyer of Treasuries, and giving the market some support," said Kim Rupert, managing director of fixed income for Action Economics. The Fed still has more than $1 trillion in mortgage-backed securities, debt issued by government-sponsored firms Fannie Mae and Freddie Mac and other long-term bonds on its balance sheet. While not all of this debt is set to mature in the next few months, the Fed still has a lot at its disposal to roll over into new bond purchases.

Even though some Fed policymakers are worried about the impact the bond buying has had on the dollar and inflation, the Fed does not seem ready to remove all its stimulus just yet. "For the foreseeable future, the Fed will have to maintain an accommodative stance. It's the only game in town."

[Oakley]

There is a big difference between buying federal debt with the proceeds of existing maturing debt and buying newly issued debt with newly issued money.

The current monetary system allows the creation of money out of thin air by banks to loan into existence, such as when the FED buys new federal government debt. But this has an inverse. When the federal government repays maturing debt, the money supply contracts, as the federal governments checking account balance goes down by the amount repaid the FED; repayment of debt to banks deflates the money supply. So if the money expands by the FED buying federal government debt and this debt is just to replace maturing debt, then there is zero effect on the money supply, and on the monetary base; the money supply goes up by the FED buying debt to replace the maturing debt and goes down by the repayment of the maturing debt. It is like breathing in and out.

Were the FED to not buy new debt to replace the maturing debt the effect would be highly deflationary. The current plan is neutral. The QE's were inflationary because new money and new debt were created.

All the while the federal government was going deeper and deeper into debt and the FED was buying his debt, the private economy was doing the opposite. Individuals and businesses were repaying debts to banks, which is deflationary. The battle between inflationary and deflationary forces it looks to me is being won by deflation. I know that prices of some commodities have increased, but there are other factors beside monetary inflation that have contributed to these price increase, and other sectors like real estate continue to experience price decreases.

I expect interest rates on the benchmark 10 year treasury to increase over the next two years, almost tripling. The effect of this interest rate increase, related to increased risk, will be highly deflationary. The interest rate on the 10 year treasury effect the value of all assets. For example, if farmland produces $10,000 in annual rent when the interest rate is 3%, the capitalized value of the land is no more than $333,333 ($10,000 / .03). If the interest rate increases to 9% then the capitalized value of farmland producing $10,000 in annual rent drops to $111,111 ($10,000 / .09). All assets are effected including non-income producing property like residential real estate. The assets of banks will be significantly effected because existing loans they have made will likewise fall in value.

[GoIllini]

$this->bbcode_second_pass_quote('Oakley', 'I') expect interest rates on the benchmark 10 year treasury to increase over the next two years, almost tripling. The effect of this interest rate increase, related to increased risk, will be highly deflationary. The interest rate on the 10 year treasury effect the value of all assets. For example, if farmland produces $10,000 in annual rent when the interest rate is 3%, the capitalized value of the land is no more than $333,333 ($10,000 / .03). If the interest rate increases to 9% then the capitalized value of farmland producing $10,000 in annual rent drops to $111,111 ($10,000 / .09). All assets are effected including non-income producing property like residential real estate. The assets of banks will be significantly effected because existing loans they have made will likewise fall in value.

[babystrangeloop]

QE2.5 is also referred to as QE2 Lite.
$this->bbcode_second_pass_quote('', '[')b]QE2 Lite Kick-Off? FOMC Preview
By YohayElam / benzinga / June 20, 2011

The FOMC is unlikely to announce a third program of quantitative easing, but will probably kick off the buying of maturing assets. This QE2 Lite program will likely be received positively by the dollar, but this also heavily depends on the words and the tone of Bernanke in the press conference . FOMC Preview with the two most important scenarios. ...

[Outcast_Searcher]

This all sounds nice, and apparently the stock market is buying it or something close.

If however, things go south and deflation looks like a serious risk, and especially if it smacks the stock market(s) hard, they'll have some emergency excuse to dive into QE3, QE4, ... QE(N) until the pain stops so fast that it'll make your head spin.

The inevitable result at SOME point is inflation, and lots of it. Eventually that HAS to hit interest rates and the markets too.

But don't worry -- your (currently) 3.1%ish 10 year and 4.4%ish 30 year treasuries are "SAFE". They WILL be paid in dollars -- but what will those dollars buy?

(Every time I'm tempted to think "gold is a bubble" I remind myself FIRMLY about this seemingly unavoidable scenario).