The FED may have to raise rates...The U.S. Federal Reserve Board is scheduled to step into the Treasury market Thursday for the fourth time as it buys bonds in an effort to hold interest rates down. And its actions could well be masking powerful underlying forces pushing rates higher.
HOW WILL THE MARKETS REACT?
Any hope of stabilization in the economy, which stock market investors have certainly grasped onto, would be expected to lessen the flight to safety trade causing Treasury prices to fall and yields to rise. Also, any sign of an economic recovery could also give rise to inflation worries and that too would lead to a rise in yields.
The focus of the Fed's activities is on bonds of around seven-year duration, which corresponds to the average term of mortgages outstanding. The yield on seven-year Treasuries has declined about half of a percentage point, which has helped to keep mortgage rates well under 5 per cent, triggering a rush in mortgage refinancing and helping to support the depressed housing sector.
The Fed has bought $17.54-billion (U.S.) of Treasuries so far in its $300-billion program scheduled to last six months, according to Bloomberg News. But the effects could prove to be short-lived.
“Given our expectations that the U.S. economy will start growing again in the second half of this year, we think the Fed should start raising rates at a pace that is likely to be measured before year-end,” said Paul-André Pinsonnault, senior fixed-income economist with National Bank Financial Inc.
The mortgage refinancing binge could also end soon. “This might last for a while, but not forever,” Mr. Pinsonnault said. National Bank expects the yield on 10-year U.S. Treasuries, which is currently at 2.65 per cent, will be allowed to move above 3 per cent.
And it might not take much for the Fed to move off its near-zero interest rate policy. If it waits too long, inflationary expectations could build, Mr. Pinsonnault said. “That would force the Fed to move more rapidly and forcefully, roiling the bond market and damaging the economy.”
Among the sellers of U.S. Treasuries could be the U.S. Fed and the banks, said Kent Engelke, the chief economic strategist and managing director for Capitol Securities Management. “When you start unwinding the fear trade, how quickly will the 10-year get back to 4 per cent?” he said. “It could be very quick.”