Fed Is Content to Let Sleeping Bond Traders Lie

(Bloomberg Opinion) -- The message to bond traders from the latest Federal Reserve meeting: Chair Jerome Powell and his colleagues see no problems with the $20 trillion U.S. Treasury market and certainly aren’t about to do anything that would disturb the peace.

The Federal Open Market Committee decided to leave the fed funds rate unchanged in a range of 0% to 0.25%, keep its asset purchases “at least at the current pace,” remained committed to “using its full range of tools to support the U.S. economy in this challenging time” and otherwise adjusted its outlook only modestly in the face of the coronavirus pandemic. The statement didn’t mention any adjustment to forward guidance, such as linking interest-rate increases to specific inflation or unemployment levels — something officials have been hinting at for weeks.

The Fed effectively foreshadowed Powell’s somber tone and cautious outlook on Tuesday, when it announced it would extend its emergency lending programs that were supposed to wrap up after September through the rest of the year. That includes the Primary Market Corporate Credit Facility and the Secondary Market Corporate Credit Facility, which combined have ignited a huge rally in investment-grade U.S. corporate bonds and pushed yields below 2% for the first time. If the central bank was so confident the American economy was on the upswing, it might not have felt the need to lengthen the terms of its programs months in advance.

After the decision, Treasury yields barely budged and the shape of the curve remained effectively the same. The benchmark 10-year yield was steady at 0.58% while five-year yields fell to yet another record-low level of 0.2437%. The latter maturity is one potential option should the Fed decide to eventually take up yield-curve control and cap short- to intermediate-term rates at the 0.25% upper bound of the fed funds rate.

This sleepy reaction is likely just what the Fed wanted when there’s heightened scrutiny around the conditions that allowed the world’s biggest bond market to blow up in March (Powell called Treasuries an “absolute bedrock of the global financial markets — it’s essential that it works well and it’s doing so now.”). It couldn’t be a more different story now. Ahead of the Fed’s decision, Jim Vogel at FHN Financial noted that once 10-year Treasury yields fall to near record lows, trading volume tends to disappear — that is to say, fixed-income investors see little reason to chase the rally.

Ten-year notes “trading consistently below .60% is supposed to be bullish – and it may prove so. The missing ingredient, however, is scale,” he wrote. “An important question for Treasuries is whether Chair Powell’s statements spur enough trading volume to change rate momentum.”

So far, Treasuries don’t seem eager to move out of their doldrums. Gold and silver prices fluctuated but ended higher, as did the S&P 500 Index, as Powell spoke about the need for “continued support from both monetary and fiscal policy” and heaped praise on Congress for acting boldly and decisively earlier during the pandemic. His remarks were arguably his most forceful yet in imploring lawmakers to act yet again with a relief package. While the Fed can help some businesses borrow, “for many others, getting a loan that will be difficult to repay may not be the answer. Direct fiscal support may be needed,” he said.

As for the Fed’s next steps, Powell acknowledged that the committee’s discussion about its longer-term policy framework was delayed by the pandemic but that it restarted at this meeting. He said it was a high priority and could have been wrapped up by the June meeting if it weren’t for Covid-19. 

“While I do not have any details to share with you today, I am confident that we will continue to make progress and will wrap up our deliberations in the near future,” he told reporters. In answering the final question of the press conference, though, he noted that any changes would be just “codifying the way we’re already acting with our policies. To a large extent, we’re already doing the things that are in there, this is just a way of acknowledging that and putting them in the document.”

As I wrote earlier this week, the most likely outcome of these deliberations will be the Fed tying future rate increases explicitly to actual inflation reaching or overshooting 2%. Other options include yield-curve control, or focusing its Treasury purchases on the longer-end of the curve.

Until then, Powell’s unofficial forward guidance was adding to his past quip that he and his colleagues are “not even thinking about thinking about” raising interest rates.

“We are not even thinking about thinking about thinking about raising rates,” he said. That should be enough to keep rates traders sleepwalking through the summer.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Brian Chappatta is a Bloomberg Opinion columnist covering debt markets. He previously covered bonds for Bloomberg News. He is also a CFA charterholder.

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