- Federal Reserve (Fed) Chairman Ben Bernanke’s dovish surprise reaffirms that the Fed is “data-dependent” and that the Fed remains committed to providing accommodation until there is more progress towards its objectives.
Over the past few years, Chairman Bernanke has been remarkably consistent on two points: he watches the economic data very closely and he convinces the Fed to provide more accommodation when there are concerns about either labor markets or inflation. September 18th’s big surprise—that the Fed has delayed tapering—was entirely in line with Chairman Bernanke’s past performances. Recent economic data have been disappointing relative to the Fed’s expectations and progress on the labor market and inflation has been frustratingly slow.
- In addition to the surprise announcement on asset purchases, there were at least two other parts of September 18th’s Federal Open Market Committee meeting that were bullish for bond markets.
First, the Fed’s guidance for the future path of the federal funds rate was more dovish than expected. In particular, the Fed anticipates that once it starts raising the federal funds rate, it will do so at a very gradual pace of 25 basis points per quarter. This is a slower pace than markets were pricing, and that has had the effect of lowering short-term interest rates, particularly those rates maturing in 2016.
Second, in his press conference Chairman Bernanke reiterated a number of familiar themes that suggest that the Fed will remain accommodative for some time. This included emphasizing that the Fed would be slow to raise rates even if the 6.5% unemployment threshold were crossed.
- The bond market’s reaction to September 18th’s announcement reflects a number of considerations.
First, the Fed decision to delay tapering has changed the market’s expectations for the eventual size of the Fed’s balance sheet. The increase in expected Fed demand pushes up bond prices and pushes down yields.
Second, by reaffirming that the Fed is “data-dependent,” its decision on September 18th reduces uncertainty about the Fed’s reaction function and dampens concerns that the Fed was being forced to stop providing accommodation. This should be reassuring to bond investors and should help lower the risk premium that has recently built up in bond yields.
Finally, the announcement refocuses the market on economic data as the primary determinant of Fed policy. As mentioned, the hard economic data have been disappointing over the past few months. At the same time, recent sentiment surveys (especially the ISM surveys) have been more optimistic and may point to a coming acceleration. How these trends play out over the coming months will determine the Fed’s next move.
- With the Fed remaining in a firmly accommodative stance for the time being, the next move in interest rates will be determined by developments in growth and inflation.
Our view is that growth is likely to remain sluggish and that inflation is likely to remain low. In an environment of sluggish growth and low inflation, bond yields are likely to remain at a lower level than where they have been trading for the past month or so.
- WA / Claymore Inflation-Linked Opportunities & Income Fund (WIW)
- WA / Claymore Inflation-Linked Securities & Income Fund (WIA)
- WA Corporate Loan Fund Inc. (TLI)
- WA High Income Fund II Inc. (HIX)
- WA High Income Opportunity Fund Inc. (HIO)
- WA High-Yield Defined Opportunity Fund Inc (HYI)
- WA Income Fund (PAI)
- WA Investment-Grade Defined Opportunity Trust Inc. (IGI)
- WA Middle Market Debt Fund Inc.(XWAMX)
- WA Middle Market Income Fund Inc.(XWMFX)
- WA Mortgage Defined Opportunity Fund Inc. (DMO)
- WA Government Reserves
- WA Institutional Government Reserves
- WA Institutional Liquid Reserves
- WA Institutional U.S. Treasury Obligations Money Market Fund
- WA Institutional U.S. Treasury Reserves
- WA New York Tax Free Money Market Fund
- WA Premium Liquid Reserves
- WA Premium U.S. Treasury Reserves
- WA Prime Obligations Money Market Fund
- WA Select Tax Free Reserves
- WA Tax Free Reserves
- WA U.S. Treasury Reserves
- WA Adjustable Rate Income Fund
- WA Core Bond Fund
- WA Core Plus Bond Fund
- WA Intermediate Bond Fund
- WA Macro Opportunities Fund
- WA Short-Term Bond Fund
- WA Short Term Yield Fund
- WA Total Return Unconstrained Fund
- WA Ultra Short Obligations Fund
- Sector Strategies
- WA Corporate Bond Fund
- WA High-Yield Fund
- WA Inflation Indexed Plus Bond Fund
- WA Mortgage Backed Securities Fund
- WA Short Duration High Income Fund
- WA Emerging Markets Debt Fund
- WA Global High-Yield Bond Fund
- WA Global Strategic Income Fund
- State-Specific Municipal
- WA California Municipals Funds
- WA Intermediate Maturity California Municipals Fund
- WA Intermediate Maturity New York Municipals Fund
- WA Massachusetts Municipals Fund
- WA New Jersey Municpals Fund
- WA New York Municipals Fund
- WA Oregon Municipals Fund
- WA Pennsylvania Municipals Fund
- National Municipal
- WA Intermediate-Term Municipals Fund
- WA Managed Municipals Fund
- WA Municipal High Income Fund
- WA Short Duration Municipal Income Fund