Despite talk of tapering, bonds have been rallying as of late. Will it continue?
Interest rates have risen sharply over the past four months. So why are bonds now rallying?
Since the start of May, yields on a US Treasury 10-year note have gone from 1.63% to 2. 77%. But, just one week ago, those yields were as high as 2.92%.
Bonds and interest rates move inversely. Lower bond prices mean higher bond yields. After all, if a bond coupon pays $15 every six months, the less you paid for that bond to begin with, the higher the percentage $15 is to whatever it was you paid.
What caused the initial run-up in bond yields was one word: “taper”. Though not actually uttered by Federal Reserve Bank Chairman Ben Bernanke, he implied it when he spoke to the US Congress on May 22. What he was suggesting the Fed would taper is the quantitative easing.
In much the same way the word “taper” hasn’t been officially used, neither has “quantitative easing”. Also called “QE”, quantitative easing is the Fed’s policy of buying US Treasury and mortgage bonds from financial institutions. That leaves a lot of cash in bank vaults for those lenders to give out to borrowers such as homeowners and businesses. And, buying bonds keep interest rates down by raising the prices of bonds.
The first round of QE began in late 2008, when yields on the 10-Year US Treasury note were close to 4%. Subsequent rounds of bond purchases help to bring those rates down to nearly 1.4% last year, the lowest it was in generations. Since the end of last year, the Fed has been buying bonds at a rate of $85 billion each month.
Tapering would involve a decrease in those purchases, though not necessarily a stop to them. Still, tapering raises the prospects that the Fed may not be there to buy as many bonds as they did before. That led to a sell-off in bonds that began in May and is one of the main reasons behind rates going up since then.
Bernanke and other Fed policymakers have said that if, when, and how much tapering will happen depends on the economic data it receives. The worst the data are, the less likely tapering will occur anytime soon.
Right now, most analysts expect tapering will begin at some point in September. But, recent data on such things as home sales and durable goods have the markets wondering how much tapering will really happen next month, if at all. And that’s helped create a small rally in bonds as of late.
So, will that rally continue? Have the markets blown out of proportion how much tapering will occur, if at all?
Answering these questions and where they think bonds will go next are Steve Cortes, founder of Veracruz TJM, and Mark Newton, Chief Technical Analyst at Greywollf Execution Partners. Analyzing the fundamentals, Cortes says there’s one major factor that is being missed by the bond market. Meanwhile, Newton says there are technical bond prices have been moving up recently – and, surprisingly, stocks also have a hand in this.
To hear Cortes and Newton on the recent bond rally and whether it will keep going, watch the video above.