What looked to be a very promising TIPS auction – possibly the most attractive in three years – dimmed considerably Wednesday when the Federal Reserve decided to hold off on tapering its bond-buying economic stimulus program. The result: Both the stock market and Treasury market soared. The announcement came at 2 p.m. and the markets moved in lockstep:
Big Bad Ben. Fed Chairman Ben Bernanke is making a habit of putting the hex on TIPS auctions — in fact he put the kibosh on this very same TIPS before it was auctioned on July 18, 2013. Back then my headline was, “10-year TIPS auction: We’ve been jawboned“. A few weeks before that auction, the yield looked likely to hit 0.65%, but Bernanke stepped in on July 10 to sooth the markets with ‘clarifying’ comments about tapering. The result was a 34 basis-point drop in yield in just 5 days. Thanks a lot, Ben.
So now, what? Today’s TIPS auction is a reissue of CUSIP 912828VM9, creating a 9-year, 10-month TIPS with a coupon rate of rate of 0.375%. Since this TIPS now trades on the secondary market, we can get a pretty good idea of its likely yield, which currently is running about 0.480%. It closed yesterday at 0.494%. While that would be the highest 9- or 10-year auction yield in more than two years, it’s still a bit disappointing. Just two weeks ago, the 10-year TIPS yield stood at 0.92%.
That’s a drop of more than 40 basis points in two weeks. It’s enough to give a buyer pause. And in fact, it’s enough to cause me to skip this auction.
In my opinion, the Treasury market just got an artificial jolt. But it won’t last because tapering is coming. When it does, there will be another jolt, causing yields to rise. That is my expectation: Higher yields are coming. That is 100%-guaranteed to happen, as long as … the economy continues to improve, the unemployment rate continues falling and Congress and the president don’t shut down the government.
What exactly did the Fed say?
You can read the statement here. What is remarkable is that the Fed sees very little bad news, but it decided to continue bond-buying at the pace of $1 trillion a year. Here is my summary:
- The economy. “Economic activity has been expanding at a moderate pace.”
- Unemployment. “Some indicators of labor market conditions have shown further improvement in recent months, but the unemployment rate remains elevated.”
- Inflation. “Apart from fluctuations due to changes in energy prices, 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.”
- The future. “The Committee expects that, with appropriate policy accommodation, economic growth will pick up from its recent pace and the unemployment rate will gradually decline.”
- Tapering? Not yet. “The Committee decided to await more evidence that progress will be sustained before adjusting the pace of its purchases. Accordingly, 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.”
- Hidden message for buyers at today’s TIPS auction? “Taken together, these actions should maintain downward pressure on longer-term interest rates …”