Credit spreads – to QE3 or not to QE3 that is the question
Posted on 21 September 2011
Looking at the relative performance of high yield versus investment grade credit, one would be forgiven for thinking that the pre-conditions are set for a sizeable risk rally if the Fed announces another QE instalment. Risk aversion has been elevated for some time – with the VIX having peaked in early August and now easing from its highs:
Some pundits are suggesting that the market has already priced in Operation Twist (given the rally in Treasuries and dealer positioning), but looking at the selloff in equities and credit, there is plenty of room for a sharp rally if sentiment improves:
Don’t get me wrong. This chart has all the hallmarks of a market that continues to roll over. It’s just that the gap between today and early August is large – and if we stick by the playbook that says buy when the government is throwing money at the problem then, well, more QE is exactly that.
While the ‘portfolio balance channel’ may prove ultimately fruitless as a means to stimulating the economy back to health, Bernanke has shown that this is the favoured strategy. If more QE is announced, then we can probably expect at least a brief respite from the European crisis.