No surprises here. The Federal Reserve noted that the economy is growing slowly and its strategy of near-zero interest rates and monthly bond buying will continue. I’ll just quote today’s Federal Reserve statement on the most predictable news of the week:
- Evidence of slight improvement. (E)conomic activity expanded at a modest pace during the first half of the year. Labor market conditions have shown further improvement in recent months, on balance, but the unemployment rate remains elevated. … The Committee expects that, with appropriate policy accommodation, economic growth will pick up from its recent pace and the unemployment rate will gradually decline …
- Inflation remains too low. Partly reflecting transitory influences, inflation has been running below the Committee’s longer-run objective, but longer-term inflation expectations have remained stable. … The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, but it anticipates that inflation will move back toward its objective over the medium term.
- Congress, you dogs. (F)iscal policy is restraining economic growth.
- The result, stay the course. To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee decided to continue purchasing additional agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month.
- The not-so-secret strategy. Taken together, these actions should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative.
- But, just in case you wondered … The Committee is prepared to increase or reduce the pace of its purchases to maintain appropriate policy accommodation as the outlook for the labor market or inflation changes.
What it means.
- The Federal Reserve desperately wants the U.S. inflation rate to rise above 2% (it is currently running at 1.8%). It is practically guaranteeing inflation higher than 2%.
- The Fed isn’t pleased by the currently slow rate of economic growth (it again took a swipe at Congress for tight fiscal policy). Second-quarter GDP came in today at 1.7%, better than expectations. Not enough, says the Fed.
- Most importantly, after having spooked both the stock and bond markets with talk of ‘tapering’ its bond buying in early July, the Fed is going to continue sweet-talking the markets that bond buying will continue, until some possibly unreachable date in the future. The Fed wants stock prices higher and bond yields lower. Period.
And for TIPS?
Today’s chart for the TIP ETF says it all (the Federal Reserve statement was announced at 2 pm EDT):
While TIPS yields have reached ‘barely tolerable’ levels in recent weeks, buyers have also been fighting the Fed, which seems determined to keep yields very low. But I do think the Fed really doesn’t want a bond bubble, so it has set off a bit of confusion about where rates are headed. That may be able to keep rates positive, at least for a 10-year TIPS.
Not that much really happened today, no big deal. I’d keep an eye on the 10-year nominal Treasury, which closed today at 2.60%. Where it goes, the 10-year TIPS, which closed the day at 0.38%, will follow.
Remember … Eternal quantitative easing drives TIPS yields down, and prices up. The 10-year TIPS breakeven rate widened out today to 2.22%, up from yesterday’s 2.14%. That makes TIPS more expensive.
Joe, I think the bond market was going through a healthy phase with the 10-year nominal Treasury rising from 1.6% to 2.75% in a couple of months, and the 10-year TIPS went from about -0.66% to about 0.59%. So the market was pricing in tapering, and that was good. But then Ben Bernanke blinked and backed off on the taper commitment. Since then, yields have dipped. I agree that if the economy is healthy, the bond-buying must end and long-term rates will rise. I could see the 10-year Treasury at 3.5% and a 10-year TIPS above 1.0%. That would mean another dip of 4% to 8% in TIP mutual funds.
Unless the economy somehow takes another nosedive, it seems like the bond buying will in fact come to a close. Isnt it virtually guaranteed that when the buying stops, interest rates will rise at least somewhat, and that this would include a rise in TIPS yields?