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The Fed funds rate may spike 6 months after the tapering concludes

Chanderlekha Nayar

Tapering and Treasury yields: Important takeaways (Part 2 of 4)

(Continued from Part 1)

Future tapering remains accommodative

Janet Yellen, the Fed chairwoman mentioned that the future tapering would remain accommodative. However, the first Fed funds rate hike could come roughly six months after the Fed finishes the bond-purchase program. The Fed is scheduled to wind up tapering by the end of October or November, 2014, which means that the first interest hike could be expected somewhere in April or May, 2015. The expected increase is Fed funds rate earlier than anticipated by markets pulled bond prices across maturities downward.

The Fed chairwoman further added, “To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy remains appropriate. In determining how long to maintain the current zero to 0.25% target range for the federal funds rate, the Committee will assess progress— both realized and expected— toward its objectives of maximum employment and 2 percent inflation.

Yellen also said, “The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.

Major fixed income ETFs such as iShares Barclays 20+ Year Treasury Bond (TLT), iShares Barclays Aggregate Bond Fund (AGG) and Vanguard Total Bond Market ETF (BND) prices plummeted on the expectation of the interest rate hike. While, floating interest rate ETF price of such as PowerShares Exchange-Traded Fund Trust II (BKLN) with top holdings in H.J. Heinz Company (HNZ) and BMC Software Finance, Inc. (BMC) was mainly unchanged. The ETF normally invest in floating rate securities that pay interest rate above LIBOR+125 basis points or 150 basis points, which moves in tandem to the market interest rate.

Continue to Part 3

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