The Treasury market’s bears may find a dose of vindication this week given that the Federal Reserve may disappoint some traders by not tweaking its bond-buying program, which could finally catapult 10-year yields above 1%, even if only briefly.
That psychological mark has proved elusive since March -- several attempts to crack through it stalled out quickly as investors anticipating that the Fed will eventually tilt its debt purchases to longer maturities to support the economy used dips in Treasury prices as opportunities to buy.
The next big moment for the world’s biggest bond market is looming in Wednesday’s policy decision by the central bank, and all eyes are on whether it alters the bond program or keeps the status quo. Most economists see officials forgoing a shift now. But with the raging pandemic posing the risk of further lockdowns and Congress failing to agree on virus-relief aid, a minority is leaning toward a move this week. That means Fed inaction could provide enough fuel to break through the headwinds around the key 1% mark.
“We are in the camp that the Fed is not going to do anything with its purchase program this week,” said Tom Garretson, senior portfolio strategist for RBC Wealth Management, which oversees $416 billion. “But there’s potential for volatility given what’s priced in. Maybe the thing that finally takes the yield back above 1% is if the Fed shies away from doing anything with its asset-purchase program.”
The 10-year yield has moved between around 0.50% -- a trough reached in August -- and just under 1% since March. It nearly broke that upper level in early December, after tepid job data appeared to temporarily lift hopes for more government spending. It was trading around 0.90% at 7:30 New York time Tuesday.
Fed officials this week will link the future of asset purchases to measures of employment and inflation without taking any immediate action to alter the pace or composition of bond buying, according to economists surveyed by Bloomberg News.
Tom Essaye, a former Merrill Lynch trader who founded “The Sevens Report,” warned clients Tuesday that share prices are also at risk of falling if the Fed disappoints. U.S. stocks are poised to open higher after a four-day slump, index futures trading suggests.
This FOMC meeting “will be the first in months where the market is fully expecting new action from the Fed, and as such the risk heading into the meeting is that the Fed isn’t dovish enough to meet market expectations, in which case we should see stocks continue last week’s declines,” Essaye wrote.
The Fed is presently buying about $80 billion a month in Treasuries broadly across the yield curve, in a program designed to put downward pressure on real borrowing costs for households and businesses. It’s also purchasing $40 billion a month in mortgage-backed securities.
This week, “there is a rare bit of monetary policy excitement – admittedly not the Fed’s ideal outcome,” BMO Capital Markets strategists Ian Lyngen and Ben Jeffery wrote in a note. “There is enough uncertainty surrounding the potential for the Committee to extend the weighted-average-maturity of the current QE program that regardless of the outcome, some subset of the market will be caught offsides.”
Sooner or Later
To be sure, there’s little expectation that volatility this week will lead to a sustained break higher in yields. That’s because if it doesn’t act Wednesday, most still see the Fed leaving the door open to adjusting its bond buying at some point in 2021, maybe even in coming months.
“We think the Fed is slightly more likely than not to extend the weighted average maturity of its Treasury purchases, though it is a close call,” Goldman Sachs Group Inc.’s David Mericle and Laura Nicolae wrote in a note.
One reason behind that view is that “Fed officials might see the winter virus resurgence as the obvious moment to shoot their last bullet, or at least a moment not to disappoint market expectations,” they wrote.
For strategists at Standard Chartered, there’s “too much uncertainty not to act.”
The Fed is probably going to ease policy Wednesday, most likely by increasing the duration of its Treasuries purchases, Steve Englander and John Davies wrote in a note.
Policy makers may also take steps such as increasing asset purchases, moves that “may be explicitly temporary or tied to economic outcomes,” they wrote.
“Taken together, these steps may be enough to limit the backing up of bond yields on a fiscal deal in Congress and encourage yields lower, faster, absent a deal,” according to the strategists.
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