Last week the market’s celebration surrounding the partial Fiscal Cliff agreement was cut short by a surprise from the minutes of the Fed’s December meeting. You see most had expected the minutes to be a relative non-event …
But showing you can’t ever take anything for granted in the markets, the minutes offered details of a surprise rift in the FOMC about when to end its current quantitative easing program. In particular, this paragraph shook markets:
“In considering the outlook for the labor market and the broader economy, a few members expressed the view that ongoing asset purchases would likely be warranted until about the end of 2013, while a few others emphasized the need for considerable policy accommodation but did not state a specific time frame or total for purchases. Several others thought that it would probably be appropriate to slow or to stop purchases well before the end of 2013, citing concerns about financial stability or the size of the balance sheet. One member viewed any additional purchases as unwarranted.”
Previously it was thought that the Fed would keep their QE program through the end of the year. And while this isn’t a declaration that QE is going to end imminently, the minutes were particularly surprising to markets because no one thought ending the current QE program was on the Fed’s mind, much less being openly discussed and argued about.
The surprise news, combined with the positive sentiment emanating from the fiscal cliff deal, sent Treasury yields to seven-month highs. As you can see in the chart below, the 30-year Treasury yield jumped to 3 percent for the first time since late April.
[Click chart for larger version]
This is important not so much because of what the Fed minutes revealed (we all know at some point the Fed will remove accommodation) but instead how the market reacted.
The market reaction to this news was pretty violent. And the sharp selling that hit Treasurys (and spiked yields) is yet another sign that the top is “in” in the bond market. Now the question you should be asking isn’t so much, “will bond yields rise” but instead “how fast and how far will they rise.”
Four-plus years into unprecedented Fed easing, last week’s price action in response to the Fed minutes tells me that markets are accepting the fact that we are closer to the end than we are to the beginning. And as such they are starting to anticipate rising interest rates.
Bond yields have already moved to multi-month highs based on the perception that the Fed may dial back QE sooner than expected. So we can only expect yields to accelerate once it becomes clear that the Fed is actually goingto remove QE from the markets — something that by the Fed’s own admission could start much sooner than is the general consensus.
Yields have been kept low by the Fed’s mass bond-buying program, and by their safe-haven status as a series of crises threatened elsewhere. But once the QE punchbowl is removed, holders of long-term bonds could take a beating. I hope you’re not one of them.