Raymond James Weekly Update: Market Not Expecting Rate Increase Until at Least July 2015

Raymond James Bond Market CommentaryThrough 2014 … and Beyond?
By Benjamin Streed
September 10, 2012

After last month’s Federal Open Market Committee (FOMC) meeting it was apparent that the group of policymakers would take a wait-and-see approach before enacting any further monetary easing or quantitative easing (QE) programs. The U.S. economy continues to be gauged by the employment situation with the primary barometer being how many nonfarm jobs are being created each month with secondary influences being drawn from jobless claims and the stubborn unemployment rate that has remained above 8% for 43 consecutive months. Last Friday we learned that a disappointing 96k jobs were added last month, down from a revised 141k in July, while previous estimates were simultaneously revised downwards further adding insult to injury. This news clearly caught the market off-guard and immediately rekindled speculation as to whether the Fed will announce further QE measures when it meets on Wednesday and Thursday of this week. Chairman Bernanke has commented that the job situation is a “grave concern” and that adding additional bond purchases to the Fed’s existing $2.3 trillion in previous QE is a clear option. As of Thursday’s close, which was prior to the payrolls figure, 10-year Treasury yields were higher by nearly 13bp pushing the yield on the benchmark security up to 1.678% and marking its highest level since August 24th. At 8:30am on Friday, upon release of the payrolls figure, the 10-year Treasury yield instantaneously dropped by more than 5bp before backing-off and finishing the week down 11.9bp as of Friday’s close. Market participants seem to be stuck between a proverbial “rock and a hard place” as weak economic data fuels further QE speculation, which could justifiably push yields in either direction. How so? Should the next round of QE be successful, it would bode well for the general U.S. economy which could in turn push yields higher as the economic health of the country continues to mend. On the flipside, yields could also go lower as a major purchaser of Treasury securities (The Fed) enters the market and consistently provides bids that are stronger than the market sustains on its own. The FOMC previously noted that it intends to keep rates at a low, or in their words “accommodative” level, through at least the end of 2014, but looking at some market signals paints a different picture.

As proof of the changing prospects, take the spread between the 2-year and 5-year Treasuries, which typically declines as bond traders expect benchmark rates to remain depressed. Currently the difference in yield between the two securities is only 39.86bp, which is near the lowest levels on record and continues a consistent trend downward that began in June 2011. For the sake of context, this was the same month that the FOMC was quotes as saying that the recovery was progressing “slower than expected” and that recent inflationary forces would be monitored but were expected to subside. Furthering the dampened growth expectations, thereby tightening the 2-year/5-year spread, the very next month the FOMC saw economic growth that was “considerably slower than expected” and that, “the downside risks to the economic outlook have increased”. Meanwhile, the implied forward rate for Fed Funds, a way to measure where traders see the effective rate over the time period, currently shows that the markets don’t anticipate any rate hike until at least July 2015. Bloomberg also reports that Citigroup’s proprietary measure of expectations for further stimulus reached a record 99% in August after having been at 82% before QE2 began in November 2010. Mark your calendar, clearly the markets will be looking forward to Mr. Bernanke’s comments on Thursday at 12:30pm.

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