Jul 23, 2013 | by Franck Cushner, CFP®
The Fed’s announcement of Q.E. eventually coming to an end elevated volatility and drove both short-term rates and long term rates higher this past month, resulting in a continued shift up of the Treasury yield curve.
Without much detail, Fed Chairman Bernanke disclosed the central bank’s plan to start reducing its debt purchases from the current $85 billion per month sometime later this year. Bernanke also went on to say that all bond buying might very well end by the middle of 2014. Such bond purchases include Treasury and mortgage bonds.
The yield on the 10-year Treasury rose to a 22 month high following Bernanke’s remarks. The 10-year Treasury ended the quarter at 2.52% as the markets digested the Fed’s remarks.
The 30-year Treasury bond yield rose above 3.5% for the first time since September 2011, ending the quarter at a 3.52% yield.
Bernanke also mentioned that the central bank’s holdings of mortgage bonds, which currently exceeds $1.2 trillion, should continue to depress yields in the mortgage bond sector with no expectation to sell any of the mortgage bond positions for sometime.
Comments by other Fed officials also influenced the markets, as Federal Reserve Bank of Richmond President Jeffrey Lacker, who dissented against additional stimulus at every Fed meeting last year, said financial markets will remain volatile as policy makers debate how and when to curtail the central bank’s asset purchase program.
Federal Reserve Bank of Dallas President Richard Fisher said investors shouldn’t overreact to the central bank’s plan to slow bond purchases. His comments were made less than a week following Ben Bernanke’s announcement on slowing bond purchases.
Ironically, as bond prices fall, their yields become that much more attractive relative to their perceived risk, thus even as bonds have fallen in price these past few weeks, their yields have become more attractive. So as bond yields increase, new buyers for bonds will enter the market and buy up supply, thus alleviating some of the price declines by taking advantage of the higher yields.
Even with the Fed possibly slowing its bond buying by year-end, it does not anticipate raising key rates, such as the Fed funds rate, until 2015 at the earliest, per the release of recent Fed minutes. This would be more of a traditional process of raising rates directly, rather than by buying bonds in the marketplace.
The official FOMC minutes from the June meeting said that the central bank is prepared to increase or decrease its bond purchases according to the outlook for unemployment and inflation, known as the Fed’s “dual mandates”. The Fed expects unemployment to decrease to 7.2 – 7.3 percent this year, with a further drop to 6.5 – 6.8 percent in 2014.
Source: Federal Reserve
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