Taper talk might have forever diluted the power shake that the Federal Reserve has been feeding the U.S. economy every month since it started its current bond-buying program in September 2012.
The yield on 10-year Treasurys climbed from just above 1.6% to just under 3% between May, when the Fed first mentioned tapering, and mid-September, when the U.S. central bank announced it had decided to stay put after all. Since then, Treasury yields have come down to around 2.6% and traders expect they’ll eventually settle somewhere between 2.5% and 2.9%.
The huge climb, in other words, has given way to a gentle and, as far as we can tell, short-lived slope. Had that been a roller-coaster ride, I’d want my money back.
The Fed too might want to consider whether the ride is worth the price.
By buying $85 billion worth of Treasurys and mortgage-backed securities every month the Fed used to be able to keep yields in the 1.4-2% range. The point of this was to keep long-term interest rates low in order to stimulate economic activity by making it easier for American businesses and families to borrow.
Taper talk, though, seems to have changed the opportunity-cost of QE3: $85 billion a month now only gets the Fed 2.5% yields at best.
That’s because QE doesn’t really work if markets don’t cooperate. If investors believe the assets purchases will cease in the not-so-distant future, they’ll start preparing for the end: “Markets front-load any re-pricing as new information arrives,” TD’s Michael Dolega, noted in a recent report. By early September, then, investors had likely priced in most of the taper. When the Fed made its surprise announcement in mid-September about delaying tapering, investors tweaked their bets again, but the adjustment was much smaller because the scale-back is still on the table and, possibly, imminent.
The small dip in Treasury yields that did occur seems the product of short-term calculations. The decision to postpone its assets-buys cutback prompted short-sellers to buy bonds to offset “soured wagers on higher yields,” the Wall Street Journal reports. As well: “Buyers who deem the Summer selloff overdone and argue that the pace of the growth isn’t strong enough for the Fed to reduce support also scooped up bonds, sending yields lower.”
But what if the Fed should need to come to rescue once more? What if the U.S. economy hit another major snag—be it a brief debt default or another serious flareup of the eurozone crisis? Bernanke has long been saying that the Fed can adjust its bond-buys up or down and stands ready to inject more stimulus if the recovery waivers. Pushing yields significantly lower from current levels, though, might require the Fed to re-commit to open-ended QE once again, Dolega told me in an interview for a prior post. That would mean taking tapering off the table entirely. But even that might not push long term rates back to 1.6%.
The protein shake, it seems, has been watered down and there is no going back.
Erica Alini is a reporter based in Cambridge, Mass., and a regular contributor to CanadianBusiness.com, where she covers the U.S. economy.