Bonds

(Washington)

The Fed shocked markets yesterday, sending Treasury yields spiking. Interestingly, the surprise was not about the Fed’s decision to unwind its balance sheet, but rather the path of interest rates. Against all expectations, the Fed said it planned to hike in December. The comments came after months of anxiety over weak US inflation. The implication of the statements is that the Fed appears to have abandoned its long-held approach of being “data dependent”.


FINSUM: Yellen has always maintained the Fed would respond to economic data for its decision-making, but in this last meeting they seem to have completely abandoned that approach. That should lower investors’ confidence in predicting Fed moves.

(Washington)

The Fed will hold a potentially monumental briefing today. Fed chief Yellen may announce that the central bank intends to reduce its balance after undertaking several years of bond purchases. A decision on interest rates is also on the line. According to investment bank Jefferies, which issues bold forecasts for what the Fed will do, it is likely the Fed will keep interest rates unchanged, but announce that it will stop reinvesting interest income in new assets. This will work as a de facto shrinking of the central bank’s balance sheet.


FINSUM: We do not have any particularly sharp insight into what the Fed will do (and we don’t think anyone really does), but we do believe that a shrinking of the balance won’t cause the bond market losses that many fear.

(New York)

Everyone on Wall Street is worried that if the ECB ends QE and the Fed begins reducing its balance that government bond yields will spike and the bond market will see big losses. However, there is another argument out there that would prove those fears completely wrong. That is the idea that QE was really only ever a signaling mechanism, a promise that inflation and the economy would move higher, which sparked a boom in shares. If that promise is removed, especially now when the market is worried about the state of the economy, it may do the exact opposite of expectations and send yields tumbling as people will flee to safer havens.


FINSUM: There are two things to weigh here—the increase in supply from the Fed selling assets, and the signaling impact of losing the Fed’s promise. We think Treasuries may see gains when the Fed starts reducing its balance sheet.

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