MW: Bonds pare loss; long-term impact of Fed in focus
By Deborah Levine, MarketWatch
SAN FRANCISCO (MarketWatch) — Treasury prices pared losses on Friday, as Asian and European investors took the Federal Reserve’s open-ended bond-purchase policy as a license to shift into higher yielding assets, including corporate bonds, stocks and commodities.
“We don’t think these Fed actions will have much of an impact on the economy though clearly they are going to be important for the markets,” said David Ader and Ian Lyngen, bond strategists at CRT Capital Group.
Indeed, yields on benchmark 10-year notes 10_YEAR +6.43% , which move inversely to prices, rose 8 basis points to 1.81%. They touched 1.84%, their highest in about three weeks, in earlier trading.
Longer-dated debt like 30-year bonds 30_YEAR +4.06% sold off as well, being the only maturity bracket the Fed’s plan won’t entail buying of.
Shorter-dated debt is more influenced by the Fed’s extended commitment to keep rates low until 2015. Five-year yields 5_YEAR +8.35% rose 3 basis points to 0.68%, while 2-year yields 2_YEAR +6.61% fell 2 basis points to 0.24%.
“With all due respect to the Fed, QE hasn’t worked very well heretofore and the market really does understand that,” CRT strategists wrote in a morning note. “Perhaps this time the Treasury weakness will prove limited against skepticism over the economic and inflationary impact.”
The bond market’s real-time measure of inflation expectations rose and mortgage debt rallied Friday as the Fed said it would begin purchases in the sector.
Targeting jobs, inflation worries
What may also limit the move in bonds is investors’ knowledge that the current lack of job and wage gains — which the Fed’s tools have little ability to affect — will keep a lid on inflation in the longer term because wages are a large portion of the cost of doing business.
And by some metrics the Fed my be targeting, the plan is indeed working: investors are moving out of low-yielding, fixed-income securities and into higher-yielding, growth-oriented ones.
“Bernanke recognized that monetary policy is a blunt tool and right of center politicians are warning that the Fed is on the cusp of losing the plot,” said Andrew Wilkinson, chief economic strategist at Miller Tabak.
“Here’s the rub: The stock market is basking in warmer waters – not just in the United States but around the world as a result of central bankers doing their jobs.”
The hope is that if the private sector gets enough of a boost, housing recovers enough and consumers are more willing to spend, the economy can grow — which will also reverse one of the big criticisms against the Fed’s easing — that it’s weakening the U.S. dollar.
The open-ended nature of the plan also gives the Fed a way to do what it can as U.S. fiscal policy continues to go nowhere, and looks unlikely to be addressed before the presidential election in November. A slew of tax breaks and spending programs due to expire at year-end threaten to push the U.S. back into a recession.
The flexibility in the program “will allow the Fed to make adjustments as the U.S. heads into the debate over fiscal policy and the budget,” said Bill O’Donnell, a bond strategist at RBS Securities.
The Fed chairman also admits “it can help the economy as we know it now, but there’s little more they can do to lean against the ill effects of a fiscal cliff, should we feel its full effects,” he said.
The risk of going over that cliff is the biggest cause of worry keeping bond investors with at least a toe in the Treasury market. And while some major, positive steps have been taken in Europe to combat its debt crisis, investors still know the problems are far from over and austerity threatens to cause a bigger recession in the euro zone.
Deborah Levine is a MarketWatch reporter, based in San Francisco.
