Tuesday, February 11, 2014

Yellen Stone-Cold on Treasury Bulls

The Fed is not on a preset course for the securities purchase program, Yellen advises.  At the same time, she acknowleges that the FOMC is ‘likely to continue to QE taper in measured steps.’  If you have been around the markets for more than 8 years, you likely remember the FOMC use of the word ‘measured’ with respect to a removal of accommodation back in 2004-2006.  The reduction of accommodation back in the mid ‘00’s was in the face of a strong economic recovery and today the reduction to the monthly additions of accommodation is undertaken with less surety of imminent recovery. 

The use of the term ‘measured’ with respect to FOMC guidance is nonetheless clear.  The Fed has provided a ‘policy-path’ expectation where tapering is expected to remain at $10B per meeting until the purchase program is ended.  Normal caveats apply with respect to unforeseen events and the addition of allowances for ‘no preset path for purchase program’ should be understood as simply advising of these caveats. 

Chair Yellen was not as dovish, bullish, sympathetic and soft as some might have imagined in her written testimony.  There are, I suppose, some hold-outs who might expect this veteran policy maker to fold under Congressional testimony and promise to provide whatever support is needed and more.  That is however unlikely and disappointment for those looking for lower Treasury yields is their lot.

The Treasury ‘short-squeeze’ has lasted as long as one might expect if it is merely that.  The market (Treasuries)has been provided some support from the known path of tapering, but even this is a discountable event which should soon be expected to lose most of its value (see http://thefedandinterestrates.blogspot.com/ ). Instead, as the ‘measures step’ taper continues, portfolio managers will rightly be drawn to the elevating concern for when policy rates will be lifted. 


For guide, earlier today I offered that the EDH5-EDH6 Eurodollar spread had come too tight at 76 bps wide from a Jan 22 wide of 96.5.  I expect this spread to widen back out in relatively short order and recover to 90-95.  With the return to trend pace economic growth, this spread should move much wider still. 

Additionally, the Treasury 5yr-30yr yield spread is currently at 2.16% from 2.22% yesterday.  This yield spread was as low as 205 bps on Jan 22 and I would expect a rather quick return to this level as 5yr Treasuries underperform 30yr Treasuries.
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