Said Jerome Powell, Chair of the Federal Reserve… This phrase can be interpreted both ways: “We’re not thinking about neither rising nor cutting rates”
In other words, Powell says that interest rates will remain stable for a very long time. However, it might not be very wise to be so assertive in a world where all the constants are constantly changing.
If the Fed says it will keep rates intact for a long time, it means that they remain committed to pump money into economy over the medium term. At least, investors hope that the Fed will do so. This situation also shapes the future of both stock markets and U.S. Treasury bonds.
I really can’t understand why Trump and some financial experts keep insisting on zero or near zero rates, because it is in fact the monetary expansion that will seal the fate of U.S. Treasury bonds. We have witnessed many times before that the correlation between policy interest rates and bond yields may always be subject to rupture. Therefore, even if the Fed cut rates to zero, bond yields won’t be falling easily if the Fed doesn’t continue to inject cash into the market. Besides the Fed Chair has already implicated that he would keep rates unchanged until 2022. I will tell you shortly why he made such a decision.
But, what does a decline in bond yields mean? It means the coupon rates of bonds are going up. I clearly remember that I used to say, “Because there is nowhere else money can go. Yields will keep falling and the bonds’ value will continue to appreciate as demand goes up”, to those who asked me why investors kept buying Treasury bonds despite the fact that yields reached a negative territory. Even though yields are negative, the ongoing demand for Treasury bonds gives investors the opportunity to carry out their second-hand trading.
“Whoops! The U.S. economy might recover faster than expected!”
So far, expectations for the future of the U.S. economic recovery involved a recession in 2020 and revival in 2021. The Fed has even revised its estimates for the United States’ GDP growth to a V-shaped recovery. However, a faster recovery than expected may let the capital market investors down. Strange but true… Because the Fed may stop pumping cash into economy vis-à-vis a fast recovery.
Although the Fed has found a way to achieve an economic recovery as a reward for its balance sheet expansion efforts that the Fed officials had showed to avoid negative expectations in the first place, the Federal Reserve will try not to cause an informational cascading in capital markets when declaring its intentions. That’s the reason why the Fed Chair said, “Interest rates will stay near zero through 2022”. As a matter of fact, showing a similar behaviour over that 2-year period prior to the start of the coronavirus outbreak, Fed had already finished expanding its balance sheet as scheduled and even started to reduce it a bit.
So, I believe that the Fed is equally capable of using its breaking bad news Management Skills in breaking good news.
