Michael Gayed: Fed Taper Be Damned, Says Bond Market
Bonds are sending some troubling messages as longer-duration bonds laugh at the taper -- and outperform.
-- Ernest Hemingway
One of the most overhyped theories out there is the notion that as the Federal Reserve tapers its bond purchases and attempts to exit the bond market, yields have nowhere to go but up. The belief centers on the idea that the Federal Reserve "controls" the bond market, and that once it is no longer in it, a vacuum will result. The problem with this idea, however, is that it assumes inflation, growth, and that the market won't replace the Fed's buying. We learned last year that the Fed has considerably less power over interest rates than we think given the yield spike of May-June.
Why is it so crazy to think that the yield curve could narrow and that yields could fall given still lackluster inflation expectations? Why is it impossible to think we can't re-enter a negative real rate environment? Sure, yields may rise if reflation hope is what drives it, but weak payroll data is a humble reminder that maybe, just maybe, we aren't at escape velocity just yet. The Fed may be on the path to stimulus reduction, but that may be more because of ineffectiveness rather than due to an improving economic growth trajectory.
Meanwhile, despite the taper, the yield curve is compressing. Take a look below at the price ratio of the iShares Treasury Bond 20+ Year ETF (NYSEARCA:TLT) relative to the iShares Treasury Bond 7-10 Year ETF (NYSEARCA:IEF). As a reminder, a rising price ratio means the numerator/TLT is outperforming (up more/down less) the denominator/IEF.
The Fed has pulled back some of its buying of longer-duration bonds, yet longer-duration bonds are getting a comparatively stronger bid. What gives? Note that strength began to take hold mid-November 2013, before the December taper, and has only been strengthening since. Could we be re-entering a risk-off period as a result, given that longer-duration bonds seem to be a good indicator of underlying risk sentiment? Maybe – seasonality does still favor equities, but it is worth watching the relative difference between Treasury bonds of varying duration to see if something wicked this way comes…
Did Federal Reserve Just Admit QE Mistake Was Deflationary?
Why Job Numbers, Fed Moves Should Mean Little to Most Investors
This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.
The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.
Copyright 2011 Minyanville Media, Inc. All Rights Reserved.
Daily Recap Newsletter