E It Came Upon A Fed Day Clear

It Came Upon a Fed Day Clear

It finally happened. The Fed exited ZIRP exactly seven years to the day after it began. The Fed raised the Fed Funds Rate range to 0.25%-0.50%. As a result the bond market did… very little. Bond market participants were well prepared for liftoff and have learned to largely ignore the Fed’s so-called “dots” (interest rate projections). Let’s discuss.

The Fed hiked the range of the Fed Funds Rate to 0.25% to 0.50%.

The Fed sees the Fed Funds Rate rising only gradually.

The Fed’s “dot plot” forecast calls for a 1.375% Fed Funds Rate at year-end 2016.

The “dot plot” indicates that the Fed does not see the Fed Funds Rate above 3.0% until beyond 2018.

The Fed sees low inflation as transitory and that building wage pressures and rising oil prices should push inflation (Core PCE) to its 2.0% target.

Although the Fed is optimistic about the economy, it sees the need for only gradual rate hikes.

Additional rate hikes are not expected to be “mechanical” or “evenly-spaced.”

The Fed said it does not expect to stop reinvesting balance sheet proceeds until well into the tightening process.

Fed Chair Yellen stated that she believes long-term borrowing costs should not “move much.”

What was the Bond market’s reaction? Following some volatility immediately after the FOMC Rate Decision and Ms. Yellen’s press conference, prices of long-dated U.S. Treasuries rallied, pushing long-term yields lower. The yield of the benchmark 10-year UST note ended that day at 2.27%. At the time of this writing, the price of the 10-year UST note was up 16/32s to yield 2.24%. The yield of the 30-year U.S. Government bond stood at 2.93% with its price up 1-12/32s.

The bond market is clearly in disagreement with the Fed’s outlook. Bond market participants have looked around the globe and within the U.S. economy, and have decided that the Fed’s transitory and cyclical phenomena are probably more structural and longer-lasting in nature. If I had to bet on who will be proved right, I would put my money on the bond market. After all, it is the bond market which really sets interest rates. The Fed knows this full well. This is why it tried to jawbone sunshine in yesterday’s commentary. It is also why the Fed is sweating over whether it can effectively raise the Fed Funds Rate in the open market.