It is known in bond circles as "the conundrum." And it may become Janet Yellen's next big challenge.
At some point this year—this week's statement notwithstanding—the Federal Reserve chairwoman is expected to preside over a rise in its benchmark short-term interest rate, the federal-funds rate, from near zero. The aim is to push rates higher across the spectrum, from debt maturing in 30 days to 30 years, to avoid fueling economic and market bubbles.
But while investors and analysts expect the Fed will have no trouble pushing short-term rates in the bond market higher, because they are closely pegged to the fed rate, some worry that the central bank will have a tougher time nudging longer-term rates up. That would complicate efforts to return the economy to a normal footing.
Then-Fed Chairman Alan Greenspan in 2005 used the word "conundrum" to describe low or falling long-term rates that persisted even as the Fed raised short-term rates at 17 meetings in a row from 2004 to 2006.
"This is the conundrum 2.0,'' said Erik Schiller, senior portfolio manager for global government bonds at Prudential Financial Inc.'s fixed-income unit, which oversees about $ 530 billion. "The Fed will have to thread the needle."
Many investors and policy makers closely watch the relationship of interest rates across time, known as the yield curve, for signs about the health of the economy.
A steep yield curve—or a big gap between short-term rates and long-term ones—is seen as healthy for many reasons.
For one, longer-term bonds are generally a reflection of investors' views on the economy. If they demand higher yields, it indicates they think growth is strong enough that inflation will eat into their fixed-interest payments over time.
As well, banks make more money by being able to borrow relatively cheaply in the short-term market and then lend for longer periods at higher rates. If banks are happy to turn on the spigot, that means more borrowing, and spending by countries, companies and individuals.
Conversely, a flat or an inverted yield curve—where longer-term rates are below those of short-term ones—has typically portended poor economic times and even recession. That last happened June 2007, shortly before the financial crisis and ensuing downturn. The time before that: December 2000, as the economy was also descending into recession.
The gap between the two-year and 10-year notes already has been shrinking, flattening the curve. The 10-year yield ended Thursday at 1.977%, a gap of 1.36 percentage points over the 0.617% rate on the two-year. At the end of 2013, that gap was 2.65 percentage points.
That spread could shrink as low as 0.25 percentage point once the Fed starts tightening, said Gary Pollack, who helps oversee $ 12 billion in assets as head of fixed-income trading in New York at Deutsche Bank AG's private-wealth-management unit.
It also could turn negative, or invert. While Deutsche Bank isn't predicting such an extreme case now, if the growth outlook deteriorates, or the Fed raises short-term rates faster than many investors expect, "I wouldn't rule it out," Mr. Pollack said.
Adding to the uncertainty, Ms. Yellen's 2015 conundrum arises from a very different situation than that of 2005.
Interest rates are strikingly low across the spectrum, mainly because the Fed has spent the better part of seven years keeping its benchmark rate near zero and buying up trillions of dollars of government bonds.
But now, as the U.S. economy strengthens, other major economies are weakening. Interest rates there are even lower, driving many global investors to buy Treasury bonds. The demand is sending prices up and pushing yields down, defying expectations that rates would begin rising in anticipation of the Fed making a move. That demand is likely to remain, and possibly even increase as the Fed raises rates, creating a paradoxical tension within the market.
The Fed does have some options. Federal Reserve Bank of New York President William Dudley, a voter on the central bank's rate-setting committee panel, suggested Feb. 27 that if bond yields don't rise, the central bank could be forced to raise rates more aggressively.
The central bank holds more than $ 2.4 trillion in U.S. government bonds, amassed through its bond-buying programs. Few investors expect the Fed to sell them, but some won't rule out sales "if bond yields do not behave like they want,'' said Thomas Roth, executive director in the U.S. government-bond trading group at Mitsubishi UFJ Securities (USA) Inc. in New York.
Foreign investors—including central banks and private investors—increased their U.S. government-bond holdings by $ 361 billion last year, to $ 6.154 trillion at the end of December, the fastest pace of increase in two years, according to Jonathan Rick, interest-rate-derivatives strategist at Crédit Agricole in New York. The holdings have surged from $ 1.849 trillion in 2004.
About half of the U.S. government bonds outstanding now are owned by global central banks, including the Federal Reserve, according to Steven Major, global head of fixed-income research at HSBC Holdings PLC.
"There is likely to be further demand for U.S. Treasury bonds in light of their competitive relative yields,'' said James Sarni, senior managing partner at Payden & Rygel in Los Angeles, which manages about $ 85 billion.
Write to Min Zeng at min.zeng@wsj.com
No comments:
Post a Comment