Why the Fed’s policy remains the key driver for US Treasuries

Market Realist

Weekly update: US Treasuries' primary and secondary markets (Part 2 of 8)

(Continued from Part 1)

Fed’s policy is a key driver for U.S. Treasuries

The previous part of this series described the geopolitical uncertainties and lackluster economic data that caused a fall in U.S. Treasury yields over the week ending August 15. Bond yields (AGG) and prices moved in opposite directions. As a result, the prices of U.S. Treasury securities continued climbing upwards in the week ending August 15, confounding bond bears. U.S. Treasury yields between one to 30 years dropped.

On August 15, yields on ten-year notes (IEF) and 30-year bonds (TBT) both fell by ten basis points to 2.34% and 3.13%, respectively. This was also their lowest level in over a year.

Impact of FOMC minutes

The Fed will release the minutes of its July Federal Open Market Committee (or FOMC) meeting on August 20. Due to continuing hiccups in the economy, the Fed minutes are likely to reiterate its dovish tune. Bond bears will need to step back and reassess strategies because both inflation and employment gains haven’t shown sustained momentum so far.

Fed’s twin goals look distant

The Fed must pursue a monetary policy that will help it achieve its congress-mandated goals of price stability and employment at optimal levels. The labor market has shown signs of improvement over the course of 2014. However, the pace of job creation slowed in July at 209,000 new jobs—compared to 298,000 in June and 229,000 in May. The unemployment rate was also higher in July at 6.2%—compared to 6.1% in June when more people joined the labor force as economic growth picked up.

Inflation at the long-term 2% level, or maintaining price stability, is the second goal. The change in personal consumption expenditure (or PCE) is the Fed’s favored measure of inflation. In June, the annualized PCE rate slipped to 1.6%. This is short of the Fed’s 2% goal.

Employment, inflation, and consumption indicators would give the Fed’s doves, led by Fed Chair Janet Yellen, reason to keep the Fed funds rate at near-zero levels for a longer time. These factors would continue to keep Treasury (TLT) yields low in the near term.

Low rates over the past few years have induced high-grade borrowers like Apple and Microsoft to issue debt at low rates and also restructure their balance sheets. Both Apple and Microsoft are part of the NASDAQ-100 Index (QQQ). The PowerShares QQQ ETF (QQQ) tracks the performance of the NASDAQ-100.

Ticker index

The iShares 7–10 Year Treasury Bond ETF (IEF) tracks the Barclays Capital U.S. 7–10 Year Treasury Bond Index. The index measures the performance of U.S. Treasury securities that have a remaining maturity of at least seven years and less than ten years. The Core Total U.S. Bond Market ETF (AGG) invests primarily in U.S. investment-grade debt, both corporate and U.S. Treasuries. The ProShares Ultra 7–10 Year Treasury ETF (UST) aims to provide daily investment performance that works out to two times the day-to-day performance of the Barclays U.S. 7–10 Year Treasury Bond Index. The ProShares UltraShort 20+ Year Treasury (TBT) aims to provide daily investment performance that works out to two times the inverse, or -2x, of the daily performance of the Barclays U.S. 20+ Year Treasury Bond Index.

Ten-year Treasury notes auction

You can read a detailed analysis of the monthly auction for ten-year Treasury notes in the next part of the series.

Continue to Part 3

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