QE2 should not be subject to large event risk. The Fed has had more than enough time to tell investors what is its plan and how it will be implemented even without giving the actual amount and timing.
It is understandable that a central bank wants to have the maximum amount of flexibility to pursue its goals, but this flexibility creates uncertainty. There have been many arguments about rules versus discretion in monetary policy and this is just one more example of the problem which exist when there is maximum discretion.
While QE2 may be difficult to implement through rules, the market has no clear idea of what will be the criteria for action and what is the link between any action and the price responses. There is no clear agreement on what is the policy objective. Is it to lower all yields on the Treasury curve or only those inside 10-year maturities? It is not clear if the objective is to get credit spreads down. It is not clear how much has to be bought to affect a 10 bps change in yields. Consequently, the event risk is high and the chance of success low.
How should an investor prepare for the Nov 3 announcement. Being aggressive is not a good choice.
It is understandable that a central bank wants to have the maximum amount of flexibility to pursue its goals, but this flexibility creates uncertainty. There have been many arguments about rules versus discretion in monetary policy and this is just one more example of the problem which exist when there is maximum discretion.
While QE2 may be difficult to implement through rules, the market has no clear idea of what will be the criteria for action and what is the link between any action and the price responses. There is no clear agreement on what is the policy objective. Is it to lower all yields on the Treasury curve or only those inside 10-year maturities? It is not clear if the objective is to get credit spreads down. It is not clear how much has to be bought to affect a 10 bps change in yields. Consequently, the event risk is high and the chance of success low.
How should an investor prepare for the Nov 3 announcement. Being aggressive is not a good choice.
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