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Bond Yields Have a Wild Ride during Fed Week

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Updated

The basis for numerous long-term interest rates

Ten-year bond yields influence everything from mortgage rates to corporate debt. They’re now the benchmark for long-term US interest rates.

Some of you might remember when the 30-year bond was the benchmark, but that changed in the 1990s. When investors want to know what’s going on in the bond market, in essence, they want to know where the ten-year bond is trading.

Note that short-term rates are still important, particularly LIBOR (London Interbank Offered Rate), which is the base rate for almost all short-term rates.

Rate information is relevant to REITs such as American Capital Agency (AGNC), Annaly Capital Management (NLY), Redwood Trust (RWT), and MFA Financial (MFA). Investors can trade the in REIT sector via the iShares Mortgage Real Estate Capped ETF (REM).

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Bond yields rise and then get hammered on the FOMC statement

After closing out the prior week at 2.18%, bond yields, as tracked by the iShares 20+ Year Treasury Bond ETF (TLT), fell by 5 basis points to go out at 2.13%. On Wednesday, right before the FOMC decision, the ten-year was trading at 2.29%.

Bonds have been heavy, as Chinese selling of Treasuries prevented yields from falling all that dramatically during the market sell-off. This pushed yields markedly higher as people swapped out of Treasuries and moved into stocks.

The market is handicapping a 50% chance the Fed hikes in December

Federal funds futures contracts can be used to estimate the market’s probability of a rate hike in December. The current probability is around 50%. The market was surprised by how dovish the FOMC statement was. The only reason not to raise rates is that inflation remains well below the target level.

As many market observers have noted, the sell-off has caused credit spreads to widen, which acts as tightening even if short-term rates don’t move.

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