By now, most investors and advisors have become familiar with the Fed’s two main policy tools; short-term interest rates and asset purchases. However, there is a third tool; forward guidance. Comments made by Fed officials can be used as a monetary policy tool. As policy rates become zero bound, “jawboning” (although often in the past) was relied upon more heavily by the Fed and other central banks (Ex. Mario Draghi’s commitment to do “whatever it takes”). One of the more effective actions taken by the Fed was extending forward guidance. This was when the Fed said it would keep rates low for an “extended period of time.” The Fed might shift to a data-based guidance rather than a date-based guidance.
The idea that the Fed might remove “extended period” from its statement has gained favor in the fixed income markets during that past week. This has caused long-term rates to move higher last week (building on some pressure from rising rates in the Eurozone). The yield of the 10-year Treasury note stood at 2.61 % at the time of this writing, up from 2.46% a week ago. This is reminiscent of last year’s taper tantrum which followed former Fed Chairman Bernanke’s comments stating that tapering could begin in late 2013. The long end of the curve is responding similarly to the prospects that the Fed could remove stimulus via rolling back forward guidance.
This begs the question: Is the rolling back of forward guidance a form of policy tightening? Last year, Fed officials went out of their way to explain that tapering was not tightening. They had a point as the Fed was still expanding its balance sheet, albeit at a slower pace. However, if the Fed was scaling back quantitative easing, could it be engaging in a form of quantitative tightening? If forward guidance is considered a quantitative policy tool, could the elimination or modification of forward guidance be considered QT? The bond market took tapering as a form of QT and appears to have a similar view of the potential removal of forward guidance.
That long-term rates have moved higher because of an increased likelihood of a roll-back of forward guidance is not surprising. The Fed would not begin to remove that form of policy accommodation if it did not believe that the economy was not sufficiently healthy. The question which should be asked is: How far might long-term rates rise before they attract more buy interest? We believe that, unless the Fed says something unexpectedly positive, buyers could be drawn into the market at levels which are not much higher than today. Although the 10-year note yield could move higher (2.85% is the upper end of our range for the balance of 2014), last week’s 10-year note auction data indicate that demand for the 10- year note was strong, particularly among indirect bidders (including central banks).
By Thomas Byrne – Director of Fixed Income – Investment Consultant
Thomas Byrne brings 26 years of financial services experience to Wealth Strategies & Management LLC. He spent the last 23 years as Director of Taxable Fixed Income for Citigroup, Inc. and predecessor firms in New York, NY. During the course of his long fixed income career, Mr. Byrne was responsible for trading preferred stock, corporate bonds, mortgage backed securities, government debt, international debt and convertible bonds. Mr. Byrne was also responsible for marketing, sales, strategy and market commentary within the taxable fixed income markets.
November 2012 – Present, Wealth Strategies & Management LLC, Stroudsburg PA
December 2011 – November 2012 – Bond Squad, Kunkletown, PA
April 1988 – December 2011, Citigroup and predecessor firms, New York, NY
June 1986 – March 1988 – E.F. Hutton, New York, NY
Thomas Byrne Director of Fixed Income
Wealth Strategies & Management LLC
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Thomas Byrne serves ad the Director of Fixed Income for Wealth Strategies Management LLC.
Thomas brings 26 years of financial services experience to Wealth Strategies & Management LLC. He spent the last 23 years as Director of Taxable Fixed Income for Citigroup, Inc. and predecessor firms in New York, NY. During the course of his long fixed income career, Mr. Byrne was responsible for trading preferred stock, corporate bonds, mortgage backed securities, government debt, international debt and convertible bonds. Mr. Byrne was also responsible for marketing, sales, strategy and market commentary within the taxable fixed income markets.
High yield/junk bonds (grade BB or below) are not investment grade securities, and are subject to higher interest rate, credit, and liquidity risks than those graded BBB and above. They generally should be part of a diversified portfolio for sophisticated investors. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.