Economy

Bond Traders Smash Yield Curve Flatter on Fed Inflation Mystery

Bond Traders Smash Yield Curve Flatter on Fed Inflation Mystery”

The Federal Reserve on Wednesday maintained its benchmark interest rate at a range of 1% to 1.25%.

The central bank did, however, offer a rosier picture of the overall economy, upping its economic growth forecast to 2.4% from 2.2%. This has implications for longer term US Treasury yields, beyond a cyclical tightening. Consequently, the Committee continues to expect that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace, and labor market conditions will strengthen somewhat further.

The decision culminated a two-day meeting of the Federal Open Market Committee against the backdrop of stubbornly low inflation and rising geopolitical tensions. With hurricanes Harvey and Irma clouding some economic data - temporarily raising gas prices, likely restraining hiring and potentially depressing growth in the July-September quarter - some analysts assumed the bank wouldn't have enough information by December to assess whether the economy had rebounded from the storms. It noted that inflation has weakened in recent months, but predicted a rebound.

JANET YELLEN: Stimulating a faster recovery than we otherwise would've had.

Yellen told reporters at a news conference that she would adjust Fed policy if she thought the causes of low inflation were permanent.

The official optimism went only so far, however.

YDSTIE: A Fed research paper found quantitative easing lowered long-term interest rates by a full percentage point. The 10-year U.S. Treasuries yield US10YT=RR rose to 2.278 percent, briefly hitting a six-week high of 2.289 percent.

The Dow Jones Industrial Average rose 41.79 points, or 0.19 percent, to end at 22,412.59, the S&P 500 gained 1.59 points, or 0.06 percent, to 2,508.24 and the Nasdaq Composite dropped 5.28 points, or 0.08 percent, to 6,456.04.

In late 2015 the central bank hiked rates for the first time since the 2007-2009 financial crisis and recession.

"Though one member noted that easier financial conditions might warrant tighter monetary policy (the conventional wisdom), another floated the more avant-garde view that elevated risky asset prices were a response to markets adjusting to structurally lower neutral interest rates - a factor which the Fed can not control", said Patel.

In equity trade, Tokyo ended 0.1 percent higher after surging two percent on Tuesday.

But other economic measures paint a contrasting picture of economic health. The Fed, though, has yet to achieve its other objective of stabilizing prices at a 2 percent annual rate.

Yellen earlier this year blamed temporary factors, such as the introduction of cheaper mobile phone plans, for the persistence of undesirably low inflation. As a result, financial markets have seemed unsure about whether the Fed would raise rates again before year's end.

The Fed's next meeting is October 31-Nov.

This morning the Federal Reserve delivered on its promise to reduce its $4.5 trillion portfolio by allowing $10B in bonds to mature in October, without replacing them.

There could well be a real-world impact of all this, not just in terms of how markets respond, because other assets bought by the Fed under QE include mortgage-backed securities - which, as anyone familiar with the history of the financial crisis will remember, is a bond backed by mortgages on people's homes or on commercial property.

The retreat will put modest upward pressure on borrowing costs, but businesses and consumers are unlikely to see much difference in the near term.

"While we do not expect United States yields or the Dollars to move much on what would be a well-telegraphed balance sheet announcement this week, there is a non-trivial risk of the Fed delaying this process". Inflation has been stubbornly low for years, suggesting the Fed should hold off. This article is strictly for informational purposes only.



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