It was quite an auction-eve day in the market yesterday, with Federal Reserve minutes released at 2 p.m., setting both the stock and bond markets into a tizzy. We are setting up for an interesting Treasury auction today for a 4-year, 8-month TIPS, a reissue of CUSIP 912828UX6.
I can depict the market’s reaction visually with this chart:
So what did the Fed say to cause this reaction? You can read the Federal Reserve minutes and judge for yourself. I’ll just hit some of the high points:
- The economy. “(E)conomic activity expanded at a modest pace in the first half of the year. Private-sector employment increased further in June, but the unemployment rate was still elevated. … The staff continued to forecast that the rate of real GDP growth would strengthen in 2014 and 2015.”
- Inflation. “Consumer price inflation slowed markedly in the second quarter, likely restrained in part by some transitory factors, but measures of longer-term inflation expectations remained stable. … The staff continued to judge … that inflation would pick up somewhat in the second half of this year. … (I)nflation was forecast to be subdued through 2015.”
- Employment. “Private nonfarm employment rose at a solid pace in June, as in recent months, while total government employment decreased further. The unemployment rate was 7.6 percent in June, little changed from its level in the prior few months.”
- Consumer spending. “(S)ome key factors that tend to support household spending were more positive in recent months; in particular, gains in equity values and home prices boosted household net worth, and consumer sentiment … rose in July to its highest level since the onset of the recession. … However, a few participants expressed concern that higher household wealth might not translate into greater consumer spending.”
- Housing. “The housing sector continued to pick up, as indicated by increases in house prices, low inventories of homes for sale, and strong demand for construction.”
- A slap at Congress. “Participants reported further signs that the tightening in federal fiscal policy restrained economic activity in the first half of the year: Cuts in government purchases and grants reportedly had been a factor contributing to slower growth in sales and equipment orders.”
- The ‘Fed-effect.’ “Financial markets were volatile at times during the intermeeting period as investors reacted to Federal Reserve communications and to incoming economic data.”
- Tapering of QE3 bond-buying. “(I)f economic conditions improved broadly as expected, the Committee would moderate the pace of its securities purchases later this year. And if economic conditions continued to develop broadly as anticipated, the Committee would reduce the pace of purchases in measured steps and conclude the purchase program around the middle of 2014.”
- Tapering data points. “(U)nemployment would be in the vicinity of 7 percent, and inflation would be moving toward the Committee’s 2 percent objective.”
What it all means
For TIPS holders and purchasers, there are a couple of important points: 1) the Federal Reserve remains on track to begin tapering its bond-buying program, possibly in the next few months, and 2) the Fed is committed to getting inflation to 2%, or above.
The end of bond-buying is already being priced into the bond market, and thus since May we’ve had more than 100 basis point increases in yields for 5-, 10- and 30-year TIPS.
Today’s 5-year TIPS auction looks like it will price with a yield as high as -0.20%, maybe even higher. I’d guess it will be in the -0.20% to -0.25% range, looking at data right now. Four months ago, it auctioned with a yield of -1.311%. Amazing.