By Karen Brettell
Jan. 27 (Reuters) – The US bond market will watch the US Federal Reserve’s continued reassurance that it will continue to buy bonds for the foreseeable future – or risk a disorderly rise in yields.
Yields hit 10-month highs this month after Democrats took control of the US Senate, raising bets on higher budget spending, rising inflation and perhaps a faster economic recovery .
Speculation has also grown that the Fed would be quicker to withdraw support for the US economy, perhaps even cutting back on bond purchases this year.
But rising yields, with 10-year yields surging more than 20 basis points in one week to 1.187%, prompted Fed officials to back down – and yields fell back to 1.036% .
Fed Chairman Jerome Powell said on Jan. 14 that it was too early for the central bank to discuss changing its monthly bond purchases.
“Powell was full blast on the message,” said Lou Brien, a market strategist at DRW Trading in Chicago. “Powell doesn’t want the market or the public to make any assumptions about the end of the Fed’s accommodations; he wants to be the one who makes the incremental adjustments to outlook. “
When the economy improves substantially, “and we can see that clearly, we will let the world know, communicating very clearly to the public, and do so well in advance of active consideration” of any policy change, Powell said.
Its ability to prevent the market from potential moves by the Fed to the forefront will be critical in determining whether future yield increases become disruptive, analysts said.
If investors start to assess less support from the Fed before the economy improves and the Fed indicates it is ready, the increases in yield could hurt any recovery and hurt riskier assets, including the actions.
“In the context of the recovery that you expect in 2021, it is essential that the Fed remain very credible in its accommodating message,” said Bruno Braizinha, interest rate strategist at Bank of America in New York.
He expects yields to gradually increase, with an acceleration expected in the second half of the year. “But for this movement to be orderly, it is necessary that the Fed keep a concerted message around the removal of accommodation,” he said.
The greatest risk of a “temper tantrum,” which could be a 50 basis point increase in 10-year yields in two months, will be towards the end of the second quarter or the start of the third quarter, when the economy is expected to rise. show improvement, Bank of America said.
“Even if the Fed remains accommodative, it will be difficult to control the message at this point,” Braizinha said. If there is a sharp increase in the area from 1.5% to 1.75% without a solid economic improvement, it “will impact the outlook for risky assets.”
Another key element regarding the impact of higher yields will be whether they are driven by higher inflation expectations.
Yield hikes triggered by Fed bond purchases could hurt stocks, but “if yields rise because the economy is on fire and inflation expectations are rising, then that’s okay with stocks, ”said Peter Berezin, chief strategist of BCA Research in Montreal.
Ten-year real yields, the yields on treasury bills that adjust to expected inflation, are trading at minus 1% after inflation expectations jumped this month to 2.17%, the most high since May 2018.
Bank stocks could also benefit from rising bond yields, Berezin said. “Not only are they inexpensive, but they are also protection against a higher yield increase than expected.”
(Reporting by Karen Brettell; editing by Megan Davies and Dan Grebler)