During the month of May, intermediate- to long-term benchmark Treasury yields rose 40 to 50 basis points, depending on the security. As the month wore on, talk in the financial media surrounding the reasons for the rise in rates centered more and more on the possibility of the Fed tapering QE. Not only did bond yields rise, but toward the end of the month, certain preferred stocks, REITs, and dividend-paying stocks also took it on the chin as fears of rising rates spread. This begs the question: Are assets so overvalued that merely tapering will cause notable selling?
Let’s remember that nobody in a position of power at the Fed is hinting that an interest-rate hike is coming any time soon. There is no danger of the Fed imminently winding down its balance sheet by selling assets. The Fed isn’t even about to stop QE altogether. In fact, the Fed hasn’t even announced that it is tapering its purchases. Instead, there is simply talk in the markets about tapering. Tapering refers to a reduction in the amount of purchases the Fed will make on a monthly basis. The reaction among investors to the prospect of simply scaling back the quantity of monthly asset purchases by the Fed reminds me of the reaction we often see when Congress discusses reducing the future rate of spending increases. When there is as much hysteria as we have seen over simply reducing the pace of future asset purchases, something is seriously wrong. From a financial markets perspective, I think it shows an incredible underlying weakness and lends more credence to the fact that the Fed is propping up financial assets across the board.
The Federal Advisory Council (FAC), a group of twelve executive-level bankers, consults with and advises the Board of Governors of the Federal Reserve System. One member is chosen by each Reserve Bank to represent that Reserve Bank’s District, and members ordinarily serve three one-year terms. The Council’s most recent meeting was on May 17, and a record of the meeting was published on the Fed’s website this past Friday. In the summary of the monetary-policy discussion that took place, it said the following: “Based on economic forecasts, and in light of ongoing economic weakness, continuing fiscal policy restraint, and the recent downturn in inflation, it is likely that current policy accommodation will continue for one to three years [emphasis added].” Notice the use of the words “current policy accommodation” and “one to three years.” We will likely be living with QE for a long time to come. But just as with prior episodes of unconventional monetary policy, there will be periods of more QE, periods of less QE, and even possibly short periods of no QE.
If bond market participants want to do what they’ve done the other times it was believed the Fed’s days of ultra-easy, post-2007 monetary accommodation was coming to an end and sell bonds, those who see the true underlying weakness in the global economy will be handed yet another buying opportunity in fixed-income assets. Even after the 40 to 50 basis points rise in intermediate- to long-term benchmark yields, we are still not at a point that the bond market is presenting widespread opportunities to put a significant amount of money to work. The bond bears still have some work to do to get us there. But have your watch list ready in case that moment arrives this year.
So far in 2013, the 10-year and 30-year Treasuries have done a good job breaking through and mostly staying above the resistance (in terms of yield, not price) that was the 200-day moving-average. From a technical analysis perspective, this is the strongest in terms of yield, and weakest in terms of price that the 10- and 30-year Treasuries have looked since early 2011. A strong selloff in equities or an indication from the Fed that tapering is out of the question could certainly change that. But, for now, momentum is on the side of yields remaining at these “elevated” (it’s a relative term) levels. Should the momentum hold, the next levels to watch are the 2.40% region on the 10-year and the 3.45% to 3.50% region on the 30-year. Those levels mark the double top in yields from October 2011 and March 2012. It is at those levels that I would put new money to work in corporate bonds (not Treasuries), depending on the bond and depending on that bond’s spread-to-Treasuries.
Financial market participants recently demonstrated that rumors of upcoming tapering are quite unwelcome. I can only imagine how bad things would be if the Fed actually stopped QE or hinted it might raise rates anytime soon. The media and markets hysteria we have seen in recent weeks surrounding the prospect of Fed tapering only confirms that investors are still uncomfortable with the thought of the financial markets and the economy managing to get by on their own without constant monetary injections from the central bank. We are four years beyond the nadir of the Great Recession, and financial markets still need the central bank priming the pump to the tune of $85 billion per month. I am not sure that “recovery” is the right word to describe the climb from the depths of the recession on the back of QE. Perhaps it is better to call the “recovery” a “thus far successful experiment in achieving a central-bank-driven, centrally-planned utopia for financial market participants.”
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