Bionic Fed is No Match for Bond Market
September 17, 2013 Leave a comment
Updated September 16, 2013, 8:04 p.m. ET
Bionic Fed is No Match for Bond Market
Tame inflation expectations don’t jibe with surging bond yields. The incoming Fed Chair will have a struggle on his or her hands keeping the Treasury market from choking off the recovery.
Steve Austin, eat your heart out. The Six Million Dollar Man could have a second bionic arm installed and still not hold a candle to Janet Yellen, the $600 billion woman. That was the approximate gain in global stocks Monday morning after the Federal Reserve’s vice chair became the presumptive nominee for the top job. Even a better, stronger and faster chairman than Ben Bernanke won’t have the power to hold off the bond market forever, though. Under the past five months of his term, the yield on the benchmark 10-year Treasury note has surged an eye-watering one-and-a-quarter percentage points.In the past, such a rise typically has been a response to higher growth or inflation expectations. But Tuesday’s consumer price index reading, expected to be 0.1% higher month-on-month, according to economists surveyed by Dow Jones Newswires, is tame.
This would bring the year-on-year rate to just 1.53%. That number hasn’t been consistently above the 2% mark since the spring of 2012. A level above 2.5% would lead the Fed to temper its bond buying, according to recent policy statements.
Even more important, though, are expectations, which can be inferred from Treasurys indexed to inflation. These suggest that, since April, the outlook for annual inflation over the coming decade has moderated to 2.1% from nearly 2.6%. In other words, bond yields are doing the opposite of what the textbooks predict when projected inflation rates are falling.
That’s because the market is experiencing conditions not described in any Econ 101 course. If consumer prices meet expectations Tuesday, it would mark the first time since spring of 2011 that 10-year Treasury yields were more than a percentage point above inflation.
Even that is pretty modest. Over the 55 years prior to the last recession, 10-year yields minus annual inflation averaged a little over two percentage points.
That difference is explained by other, fuzzier factors. Those include how quickly the Fed’s bond-buying program unwinds and how long overnight rates, which the Fed controls directly, will remain near zero. The Fed is expected to announce the first cut to its bond purchases on Wednesday.
If growth forecasts pick up, then rising rates are fine. If not, whoever succeeds Mr. Bernanke might want to invest in a bionic printing press.
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