The Irony

The aim of the QE2 was to lower the borrowing cost by injecting more liquidity (well.. printing money) into the system. It invovles the Fed monetizing to buy long term Treasuries in the market to lower the long term interest rate. However, because the market is selling more than the Fed's buying effort, the yield has risen. The market is also pricing in the increased funding pressure from the extension of Bush tax cut ($850 billion).  As a result, mortgage rates have actually gone up. This won't definitely help those average Americans trying to pay off their mortgages.

Another way of looking at the increasing yields is the market's anticipation that the economic recovery will be accelerated in 2011 due to the tax cuts. For instance, the market is anticipating that many large U.S. multinationals will finally begin to spend their cash they have been hoarding in cap-ex as it is tax deductible.

Back to QE2, prior to the announcement of QE2, the market was anticipating another round of QE2 due to the comment made by Bernanke. Some market observers were expressing concern that QE2 will create an unintended consequence: rising yield as the market price in higher expected inflation from monetization by the Fed. This is exactly what is happening right now with 10-year TIPS (inflation adjusted bond) yield spread has risen to 232 basis points.

Contrary to the Fed's claim of its no concern for inflation, the producer price index has risen by 0.9% for just November alone. Producers will eventually pass on increased input costs to consumers in near future. The food and energy prices have already risen quite dramatically over this year as the prices of corn, wheat and crude oil futures can tell. It's my belief that the crude oil price will continue to climb as the demand from the emerging markets continue to pick up and some additional liqudity injected into the market find its home in the futures market.