The message from the bond market after Wednesday’s brief leap in yields is clear: The Federal Reserve is standing by to prevent an alarming increase in rates no matter how much debt the U.S. Treasury sells amid the pandemic.
Investors have been acting for months as if the Fed has already unleashed one of the remaining tools at its disposal -- yield-curve control, a policy of capping rates to keep them from rising too quickly and squelching an economic rebound. And this week was no exception.
The old adage of “Don’t fight the Fed” is at work here. The mere prospect of central-bank action is keeping yields not far from historic lows. In the world’s most important debt market, yields are stuck in a trading range so tight it has few precedents, even after rates reached a four-month high Wednesday as a U.S. coronavirus-relief package appeared to be taking shape.
As they have for months, buyers emerged to bat yields back down, preserving the sense of calm in fixed income that’s persisted even in the face of the Fed’s August pledge to let the economy run hot to fuel inflation. That episode also merely drew in purchasers as benchmark yields climbed toward 1%. These are telling lessons for investors across asset classes, less than two weeks before U.S. elections that could pave the way for an even bigger wave of government spending.
“Yields are almost behaving as if we have yield-curve control already,” said Esty Dwek, head of global market strategy for Natixis Investment Managers, which oversees about $1 billion. “The yield rise will probably remain contained because the Fed is more important than anything else and they will limit it.”
Call it stealth yield-curve control, as Fed policy makers have pushed back on the idea of capping yields. It’s a step that central banks in Australia and Japan have already taken. The Bank of Japan has been pinning 10-year rates at around zero, while the Reserve Bank of Australia targets three-year yields at 0.25%.
In the U.S., yields have been boxed in from both directions. On the upside, the potential for Fed action should the economic picture darken, along with overseas buying and haven demand because of worries about the pandemic, are keeping long-term yields in check. On the downside, the central bank’s reluctance to drive policy rates below zero creates a floor.
Stuck Weathervane
The upshot is that the 10-year Treasury yield, the benchmark for global borrowing and a key weathervane for equity investors, has swung by a mere 23.2 basis points from high to low in September and October. That would be the narrowest two-month range since 2018, and one of the smallest of the past couple decades.
The rate is now at 0.8%, after touching the highest since June on Wednesday on bets that lawmakers will forge a stimulus package this week. As in other recent selloffs, buyers quickly knocked yields down from the day’s highs. The options market this week has seen trades targeting yields to stick around current levels for the rest of the year, and the consensus on Wall Street is that the 10-year yield wont eclipse 1% until late 2021.
With speculation building that a Democratic sweep in November could lead to supersized stimulus spending and jolt yields higher, the bond market’s placidity may be a source of comfort for equities investors. There may be less reason to fear a selloff similar to the so-called taper tantrum of 2013, when yields surged after then-Fed Chairman Ben Bernanke suggested the central bank might scale back its asset purchases.
American taxpayers are also benefiting from low rates. The Treasury is selling record amounts of debt, but it just wrapped up a fiscal year paying the least to service the nation’s obligations since fiscal 2017.
The Fed is still purchasing about $80 billion of Treasuries and at least $40 billion of mortgage securities a month. Policy makers said in September that they would continue buying at least at that pace to “sustain smooth market functioning and help foster accommodative financial conditions, thereby supporting the flow of credit to households and businesses.”