Low rates and a steep yield curve send investors fleeing treasuries into stocks
We explained earlier the risks of low short term rates. The steep yield curve both gooses the stock market but does nothing for the credit market. QE2 is causing people to take their funds out of the US and seek more profitable investments elsewhere. Via Pimco:
As the conflict in Libya intensifies, higher energy prices may result in higher inflation expectations around the world. In emerging market (EM) countries, which have already experienced higher growth and inflation, such heightened inflation expectations could encourage further EM central bank tightening.The stock market has been on fire because the Fed has been buying treasuries to the tune of 75 BB per month. This lowers the yield on treasuries but also sends fixed income investors fleeing because their investments can't even keep up with inflation.
EM markets have also experienced the effect of capital inflows from the developed markets driven by the Federal Reserve’s quantitative easing (QE2). Chairman Ben Bernanke dubbed QE2 a “virtuous circle,” a domino effect of lowering longer term Treasury rates that drives private sector capital into stocks and other risk assets. With a stronger U.S. economy emerging, profit expectations would also rise and stock prices would be driven up even further. As the uncertainty grows about how high oil prices could rise, the Treasury market enjoys a “flight to quality” of lower rates. And with the Federal Reserve continuing to purchase Treasury bonds, longer term interest rates fall even further. This has the potential to increase inflation risk in EM markets if more capital from developed markets flows to EM economies, driven by higher local rates and stronger currencies.