Market Overview

QE Is Over; Bull Bond Market Likely Isn't

Share:
QE Is Over; Bull Bond Market Likely Isn't

The Federal Reserve Open Market Committee (FOMC) voted 9-1 on Wednesday to end QE3. The move was widely expected, and in its statement the Fed confirmed that it has no imminent plans to raise short-term interest rates.

Both the equity and credit markets took the announcements in stride. The S&P 500 index fell only 0.1 percent and 10-year note yields rose three basis points and closed at 2.32 percent.

In its statement the Fed upgraded its appraisal of labor market conditions, saying “underutilization of labor market resources is gradually diminishing.” The Fed also sought to downplay the concerns about the persistently below target inflation rate. The Fed statement said that the “likelihood of persistently low inflation has actually diminished since earlier this year.”

Related Link: Bond Market Rallies To Yearly Highs On The Back Of Weak Data Falling Equity And Oil

The lone dissenter was Narayana Kocherlakota, president of the Federal Reserve Bank of Minneapolis, who argued inflation was rising too slowly to stop buying bonds.

What's Next?

The move to end asset purchases was foreshadowed since last spring when then-Fed Chairman Ben Bernanke first spoke of tapering bond purchases.

Since the tapering began in December the Fed has adhered to a steady, consistent scheduled to avoid disrupting financial market. Investors have widely assumed the end of QE3 would be announced at the meeting. The result has been a bull market for U.S. Treasury bonds with yields falling from 2.96 percent to start the year to as low as 2.14 percent earlier this month.

In the bond market, prices move inversely to yields. Investors in high-grade coupon notes, bonds and ETFs have enjoyed double-digit returns so far this year.

The end of QE3 will not mean the end to bond market rally. Falling inflation rates in Europe and slowing growth in China will continue to keep downward pressure on U.S. interest rates. The liquidity in the U.S. Treasury market, combined with the pick-up in yields over other sovereign debt, continues to attract overseas funds. Wednesday's announcement also provided the underpinnings for a strong move higher in the dollar against the euro.

Foreign investors are not only getting capital appreciation with their U.S. bond holdings, but foreign exchange gains as well. Foreign capital flows into U.S. bonds will continue to take up the slack in the credit markets as the Fed pulls out.

In addition to announcing the end to QE3, the Fed reassured investors it would keep its Fed funds rate at zero for a “considerable period”. Most market participants do not expect to see a rate rise until the middle of next year.

The Fed has not completely withdrawn its support of the bond market. In fact, it will continue to buy bonds. Today's announcement just signals the end of printing money to make these purchases. By pledging to maintain its balance sheet of treasuries and mortgages at $4.5 trillion dollars the Fed is committing to replace its maturing bonds by purchasing new issue from the Treasury during its auctions.

Posted-In: Federal Reserve FOMC QE3Bonds Top Stories Markets Best of Benzinga

 

Related Articles

View Comments and Join the Discussion!