The Fed’s monetary policy influences bond markets
Last week’s Federal Open Market Committee (or FOMC) meeting statement included an important detail about monetary policy. The Fed would announce an end to tapering its monthly bond purchases of long-term Treasuries (TLT) and agency-backed securities at its October meeting—if economic data was on track.
After the end of tapering is announced, financial markets will start the countdown to the start of the Fed’s rate tightening cycle. Two important factors include:
- The meaning of rate increases coming in a “considerable time” after tapering ends
- Convergence to the Fe’’s employment and inflation goals
The Fed repeatedly harped on the “considerable time” theme in recent FOMC statements. Last week, Fed Chair, Janet Yellen clarified that rate increases depend on data. To learn more about Fed Chair, Janet Yellen’s take on forward guidance, please read the Market Realist article, “Must-know: Janet Yellen’s take on the Fed’s forward guidance.”
The figures for non-farm employment and inflation were way below expectations in August. This was disappointing because job creation and the Consumer Price Index (or CPI) were reaching the Fed’s goals. While the Fed’s favored inflation measure is the change in Personal Consumption Expenditure (or PCE), the CPI is usually slightly higher than the PCE.
If the separation from the Fed’s goals continues, bond yields would stay low for a longer period. The rate tightening would be postponed. This would benefit fixed-income exchange-traded funds (or ETFs) like the iShares 20+ Year Treasury Bond ETF (TLT), the Vanguard Total Bond Market ETF (BND), and the iShares 7–10 Year Treasury Bond ETF (IEF). A rate increase that’s in the future would also benefit stocks and ETFs like the SPDR S&P 500 ETF (SPY) and the SPDR Dow Jones Industrial Average ETF (DIA).
If August’s data was a mistake, the reverse would hold true. Either way, the October FOMC may be critical in defining “considerable time.”
In the next part of the series, we’ll discuss other economic data that will likely influence high-grade bond yields in the near term.