Today marks the second time this year that the Federal Open Market Committee (Fed) will announce its decision on interest rates. On the surface the meeting looks to be somewhat boring: With jobs showing some strength and gas prices getting dangerously close to $4 a gallon, few analysts are expecting the Federal Reserve to announce a new quantitative easing program. At the last Fed meeting in January, Ben Bernanke and his colleagues did surprise the market with language about economic conditions being “likely to warrant exceptionally low levels for the federal funds rate at least through late 2014.” Since the Fed made that statement, many analysts and pundits continue to expect bond yield levels to stay contained, given that the Federal Reserve has assured us of being the primary anchor to the term structure of rates.
It would be nice to believe the Fed can unilaterally control the fate of the bond yields, but I would argue that the future direction of bond yields is less about Federal Reserve bond buying and rate anchoring, and more a question of whether economic growth and confidence continues to improve. The bearish community is howling about a Chinese slowdown, continuing problems in Europe, and declining money velocity, and there’s no doubt that an escalation in these forces could keep bonds yields lower for longer than many believe possible. But if economic growth continues to improve and confidence picks up appreciably, then formerly skittish investors may dump their low yielding bonds at the expense of higher yielding alternatives.
I don’t expect anything but boring news today, but I won’t be surprised if a better than expected economy and higher bond yields force the Fed to reset interest rate expectations sometime in the near future. The market reaction to a rate reset? Well, that’s a blog post for another day.
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