NEW YORK, Nov. 2 (Reuters) – Investors are monitoring everything from bond volatility to measures of inflation as they attempt to assess how an expected unwinding of the U.S. Federal Reserve’s easy monetary policies will impact on the steps.
Most market participants believe the Fed will announce a timetable for cutting its US government-backed bond purchase program by $ 120 billion per month after its November meeting on Wednesday.
The central bank has done everything it can to prepare investors for the onset of a downturn and has so far avoided the kind of gyrations that hit markets in 2013, after then Fed chief Ben Bernanke, alluded to the policymaker’s thinking about plans to withdraw his financial support during an appearance before lawmakers. Bond yields soared and stock prices fell during the so-called “tantrum” that year. However, yields fell as stocks rose as the Fed gradually unwound its $ 85 billion in government bond purchases in 2014.
Changing expectations about how aggressively the Fed will need to act this time around in order to contain the spike in inflation have already caused rates to move on shorter-dated Treasuries, even as equities have reached new heights. Read more
“You can’t anticipate what it means when a central bank suddenly stops buying $ 120 billion in securities each month,” said Bryce Doty, senior portfolio manager at Sit Investment Associates. “But once it really stops, there is an impact.”
Here are various metrics that investors are watching.
The 10-year breakeven point – which shows inflation expectations by measuring the yield spread between 10-year inflation-protected Treasury securities, or TIPS, and 10-year Treasury bills – is near multi-year highs, suggesting that investors increasingly believe the current inflation crisis may last longer than expected.
Signs that the central bank is backing down on its view on inflation as a transitory could raise expectations about how quickly policymakers will raise rates.
“We are concerned that the central bank may make a policy error and raise rates sooner than it should,” said Tom Martin, senior portfolio manager at Globalt Investments.
The most recent Fed dot plot illustrating the expectations of policymakers shows that around half of them will see Fed rates rise by the end of next year, the other half ‘expecting take-off by the end of 2023. read more
The spread between the yields offered by the benchmark 10-year Treasury bill and the dividend yield of the S&P 500 (.SPX) recently opened to its widest since May 2019, potentially diminishing the attractiveness of some stocks. for investors seeking income.
The 10-year Treasury bond yield is already up about 67 basis points from this year’s low and could rise further as investors take into account the Fed’s interest rate hikes.
“This really means that interest rates are going to rise in the future and that will have an effect on stock prices,” said Stephen Tally, COO at Leo Wealth.
Near-zero interest rates and massive monthly bond purchases helped ease nerves and dampen volatility as global markets grapple with the pandemic.
Some of that volatility is now returning as investors adjust their positioning for a Fed cut and possible rate hikes. In bond markets, investor expectations for fluctuations in the Treasury market as measured by the ICE BofAML US Bond Market Option Volatility Estimate (.MOVE) index are near post-pandemic highs.
The decline in central bank support and the prospect of policy tightening “gives more importance to every major economic data point that comes out,” said Chuck Tomes, associate portfolio manager at Manulife Asset Management in Boston.
EASE OF REPO
Some investors will be watching the use of the Fed’s overnight repo facility as an indicator of how less accommodative monetary policy is affecting market liquidity.
The facility allows counterparties such as money market funds to deposit cash with the central bank. The volume of the Fed’s overnight repo facility recently hit a record high of $ 1.6 trillion.
The robust volume suggests that the markets are brimming with liquidity and less vulnerable to upheaval. Signs that liquidity is on a downtrend as the Fed withdraws support could bode ill for riskier assets, analysts said.
“I see the boarding facility as the canary of the coal mine,” said Bryce Doty of Sit Investment Associates.
Reporting by Saqib Iqbal Ahmed; Editing by Ira Iosebashvili and Marguerita Choy
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