In the midst of a dramatic seven-day bond selloff, extending from Tokyo to Frankfurt, London, New York and all bond markets in between, Chair Yellen chose today to add verbal fire to stoke the bond rout. In the early hours GLOBAL BONDS had tried to stage a rally from the previous days of endless selling. (It seems that the ECB was in buying European peripheral bonds from Spain and Italy.) Once Yellen began her remarks the BOND onslaught began anew. The key paragraph in the Yellen interview: “We need to be attentive–and are–to the possibility that when the Fed decides it is time to begin raising rates these term premiums could move up and we could see a SHARP JUMP IN LONG-TERM RATES” (emphasis mine). Upon the utterance of those six words the markets took note and the selling of all bonds in Europe and the U.S. accelerated.
When the Fed Chair stated that term premiums could move up, Yellen was referring to the amount of interest investors will demand to hold notes and bonds over a longer duration, costing longer maturity bonds even more in value. It seems strange that Yellen would choose such an inopportune time to bring added pressure to the recent selloff. I think some commentators like Steve Liesman have comprehended the Fed Chair in what she did today. Yellen wants to get ahead of the coming interest rate rise and rather than cause an avalanche upon the actual event of raising rates, the Fed is trying to turn the rate increase into a sell the rumor, buy the news type of event. If the Fed raises rates in June and the BONDS WERE TO ACTUALLY RALLY, Yellen could then proclaim that it was actually no big deal for the markets to absorb and the FED was acting prudently. The Fed communications problem has morphed into a mind game.
Not content with only rattling the bond markets, Janet Yellen opined on the stock markets–“equity-market valuations at this point are quite high.” The SPOOS and NASDAQ went from higher on the day to down more than 1% on its lows before a short recovery at the end of the day. Editorial: FIRST, FED CHAIRS HAVE NO BUSINESS OPINING IN AN OFFICIAL CAPACITY ON EQUITY VALUATIONS. SECOND, IF THE FED OR FSOC ARE CONCERNED ABOUT FINANCIAL INSTABILITY THEN UTILIZE YOUR MANDATED TOOLS AND EXERCISE MACRO-PRUDENTIAL REGULATIONS AND RAISE MARGINS ON ALL EQUITY ACCOUNTS. Otherwise keep your opinions on stock market metrics to yourself.
***Why does the FED want to raise rates in spite of tepid economic data? It seems that the FED wants to put into use its tools to drain liquidity from the credit system–the use of the O/N RRP and the IOER (see April 15 post) are in the hands of SOMA‘s Head, Simon Potter. It appears that the O/N RRP/IOER mechanism works best if interest rates are above ZERO so better to raise the RRP rate to 25 basis points and lift IOER to 50 basis points and see if the new facility can successfully drain large amount of excess reserves in the credit system. The Fed is anxious to turn the theoretical into practical. What better way then to get the rates off the zero bound?
***The recent action in the global bond markets has proved to be a problem for ECB President Mario Draghi. The flight from U.S. debt has led to a correction in the U.S. dollar, which seems counterintuitive for higher interest rates should prove beneficial for the DOLLAR. However, it is not short rates rising but rather the long end, which is seen as global investors moving out of dollar assets. This is because of the failure of the U.S. economy to be robust enough to support the long-held optimism about a growth story in the U.S. far surpassing Europe. As the movement in the yield curve indicates, it has been investors selling bonds that has sent long rates higher and the short end of the curve has been well anchored.
The global aspect of the bond rout has resulted in the complete retracement of EURO currency depreciation and the drop of the Italian, Spanish, German and French yields since Mario Draghi’s QE announcement January 22. The EURO FX closed at 1.1366 on January 22 and today it closed at 1.1360. German BUND futures made a low of 153.81 on that day and today closed at 153.80. The French Oat made new lows from the January key while Italian notes also closed below its low of the benchmark date.
As of today, President Draghi’s QE plan has failed to achieve a weaker euro, lower bond rates or any economic growth beyond previous projections. It will be interesting to hear Draghi’s next press conference if the QE program continues to underwhelm. The pressure will be on the ECB to try to keep bond sellers on edge and find times to buy the programmed amount of 60 billion euros every month and cause traders to cover their short positions. It is just another moment when central banks are forced to play mind games with the markets.