While we’re waiting for more data on today’s 10-year TIPS reopening, I thought I’d take a look at the minutes statement issued Wednesday by the Federal Reserve. It came on the same day as a weak inflation report, causing double tension in the Treasury markets.
Here is how the TIP ETF (which holds a broad range of TIPS through all maturities) reacted to the Fed minutes, which were released at 2 p.m.:
What did the Fed say that caused this reaction? You can read the minutes for yourself, but here is my summary:
- Economy is improving, jobs are still a problem. “(E)conomic activity is expanding at a moderate pace. On balance, labor market conditions improved somewhat further; however, the unemployment rate is little changed and a range of labor market indicators suggests that there remains significant underutilization of labor resources.”
- Inflation isn’t high enough. “Inflation has been running below the Committee’s longer-run objective.”
- Bond-buying stimulus is nearly complete. “Beginning in October, the Committee will add to its holdings of agency mortgage-backed securities at a pace of $5 billion per month rather than $10 billion per month, and will add to its holdings of longer-term Treasury securities at a pace of $10 billion per month rather than $15 billion per month.”
- But the Fed is still influencing the bond market. “The Committee’s sizable and still-increasing holdings of longer-term securities should maintain downward pressure on longer-term interest rates …”
- Short-term interest rates will remain near zero. “The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the Committee’s 2 percent longer-run goal.”
The market reaction yesterday was pretty simple: Stocks up, bonds down. The Wall Street Journal noted that the stock market was rejoicing:
“The Fed cheered the market a little bit yesterday with keeping in the ‘considerable time’ language,” said Karyn Cavanaugh, senior market strategist at Voya Investment Management.
In the bigger picture, Ms. Cavanaugh said the improving economy, which could translate into higher corporate profits, and accommodative monetary policy in other regions should continue to lift stocks.
The bond market, though. found things to worry about, as noted in this separate Wall Street Journal report:
But what spooked bond investors was that Fed officials expect the official interest rate to end higher by the end of next year compared with their predictions in the June meeting. The median forecast from Fed officials sees the fed-funds rate at 1.375% by the end of 2015, compared with a 1.125% forecast in June.
The latest forecasts suggest “a faster pace of rate increases next year,” which sent bond yields higher, said Todd Hedtke, vice president of investment management for Allianz Investment Management, which manages more than $600 billion in assets globally.
Mr. Hedtke said the Fed’s message was “confusing” to bond investors, causing the gyrations in bond prices. He expects volatility in bond prices to rise as the Fed moves closer to raising interest rates.