{"id":115833,"date":"2021-12-16T12:40:00","date_gmt":"2021-12-16T17:40:00","guid":{"rendered":"https:\/\/ibkrcampus.com\/?p=115833"},"modified":"2023-02-10T13:32:05","modified_gmt":"2023-02-10T18:32:05","slug":"why-doesnt-the-bond-market-take-the-fed-at-its-word","status":"publish","type":"post","link":"https:\/\/www.interactivebrokers.com\/campus\/traders-insight\/securities\/fixed-income\/why-doesnt-the-bond-market-take-the-fed-at-its-word\/","title":{"rendered":"Why Doesn&#8217;t The Bond Market Take The Fed At Its Word?"},"content":{"rendered":"\n<p class=\"wp-block-paragraph\">We\u2019ve previously asserted that Federal Reserve Chair Powell has <a href=\"\/campus\/traders-insight\/securities\/macro\/goldilocks-is-a-68-year-old-man-in-a-suit\/\">a remarkable ability to morph into Goldilocks when necessary<\/a>, and it appears that he utilized that superpower once again yesterday.&nbsp; The FOMC\u2019s message did not seem particularly market-friendly \u2013 doubling the pace of tapering, a dot plot that indicates median estimates of three rate hikes over the next two years, and ditching the word \u201ctransitory\u201d from the inflation discussion \u2013 but stocks rallied sharply and bonds recovered from early losses.&nbsp; The Fed told us when they anticipate taking away the proverbial punchbowl but the revelers didn\u2019t seem to care.<\/p>\n\n\n\n<p class=\"wp-block-paragraph\"><a href=\"\/campus\/traders-insight\/securities\/macro\/what-to-expect-when-youre-expecting-the-fomc-december-2021-edition\/\">We discussed the potential for the positive reaction<\/a> to an unpleasant message yesterday.&nbsp; \u201d<em>As I write this, we are experiencing our third straight day of selling.&nbsp; It is possible that traders\u2019 expectations have been sufficiently suppressed to allow a bit of a relief rally if today\u2019s messaging is less dire than feared<\/em>.\u201d The afternoon session indeed had the character of a relief rally, with stocks taking sequential legs higher as the likelihood of a scary answer during the press conference waned.&nbsp;<\/p>\n\n\n\n<p class=\"wp-block-paragraph\">Bear in mind that the faster taper was likely factored in, something else <a href=\"\/campus\/traders-insight\/securities\/macro\/what-to-expect-when-youre-expecting-the-fomc-december-2021-edition\/\">we noted yesterday<\/a>.&nbsp; There clearly was enough consensus that faster rate hikes could be part of the prescription as well.&nbsp; And while the \u201cT-word\u201d vanished from the FOMC\u2019s statement, <a href=\"https:\/\/www.federalreserve.gov\/monetarypolicy\/files\/fomcprojtabl20211215.pdf\">their median prediction for PCE inflation<\/a> drops from 5.3% this year to 2.6% next year to 2.3%, 2.1% and 2.0% in the coming years.&nbsp; That seems like a wonderful way of saying inflation is transitory without using the actual word.&nbsp;<\/p>\n\n\n\n<p class=\"wp-block-paragraph\">One might wonder how that prediction might be achieved.&nbsp; The answer appears to be a combination of hope that the worst of the global supply shocks will ease and faith that a series of target interest rate rises will do the trick.&nbsp; The chart below shows a better-formatted version of the dot plot contained in the FOMC statement:<\/p>\n\n\n\n<figure class=\"wp-block-image size-full\"><img decoding=\"async\" width=\"1096\" height=\"651\" data-src=\"\/campus\/wp-content\/uploads\/sites\/2\/2021\/12\/Dot-Plot.png\" alt=\"Implied Fed Funds Target Rate\" class=\"wp-image-115845 lazyload\" data-srcset=\"https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2021\/12\/Dot-Plot.png 1096w, https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2021\/12\/Dot-Plot-700x416.png 700w, https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2021\/12\/Dot-Plot-300x178.png 300w, https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2021\/12\/Dot-Plot-768x456.png 768w\" data-sizes=\"(max-width: 1096px) 100vw, 1096px\" src=\"data:image\/svg+xml;base64,PHN2ZyB3aWR0aD0iMSIgaGVpZ2h0PSIxIiB4bWxucz0iaHR0cDovL3d3dy53My5vcmcvMjAwMC9zdmciPjwvc3ZnPg==\" style=\"--smush-placeholder-width: 1096px; aspect-ratio: 1096\/651;\" \/><\/figure>\n\n\n\n<p class=\"wp-block-paragraph\"><em>Source: Bloomberg<\/em><\/p>\n\n\n\n<p class=\"wp-block-paragraph\">We see that the median projection (green line) showing 3 rate hikes in each of 2022 and 2023.&nbsp; That implies a rate expectation for the end of 2022 to be between 0.75 and 1%, and a median projection for the end of 2023 to be between 1.5 and 1.75%.&nbsp;&nbsp; We see that Fed Funds futures (white) roughly agree with those projections.&nbsp; The end of 2023 is roughly 2 years from now.&nbsp; Yet the 2-Year Treasury note is currently yielding about 0.625%.&nbsp; That seems like a significant disconnect.<\/p>\n\n\n\n<p class=\"wp-block-paragraph\">We saw the 2-year note gyrate wildly in the aftermath of the FOMC meeting, as shown below:<\/p>\n\n\n\n<figure class=\"wp-block-image size-large\"><img decoding=\"async\" width=\"1100\" height=\"517\" data-src=\"\/campus\/wp-content\/uploads\/sites\/2\/2021\/12\/2-day-2-year-1100x517.png\" alt=\" 2-year note \" class=\"wp-image-115846 lazyload\" data-srcset=\"https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2021\/12\/2-day-2-year-1100x517.png 1100w, https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2021\/12\/2-day-2-year-700x329.png 700w, https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2021\/12\/2-day-2-year-300x141.png 300w, https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2021\/12\/2-day-2-year-768x361.png 768w, https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2021\/12\/2-day-2-year-1536x722.png 1536w, https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2021\/12\/2-day-2-year.png 1918w\" data-sizes=\"(max-width: 1100px) 100vw, 1100px\" src=\"data:image\/svg+xml;base64,PHN2ZyB3aWR0aD0iMSIgaGVpZ2h0PSIxIiB4bWxucz0iaHR0cDovL3d3dy53My5vcmcvMjAwMC9zdmciPjwvc3ZnPg==\" style=\"--smush-placeholder-width: 1100px; aspect-ratio: 1100\/517;\" \/><\/figure>\n\n\n\n<p class=\"wp-block-paragraph\"><em>Source: Bloomberg<\/em><\/p>\n\n\n\n<p class=\"wp-block-paragraph\">After a quick lurch to higher yields when the meeting statement was released, the 2 year note settled back to trade roughly unchanged.\u00a0 This morning we see rates decline slightly.\u00a0 Somehow, even as one portion of the fixed income markets shows a 1.5% rate projection, another shows 0.625%\u00a0 what gives?<\/p>\n\n\n\n<p class=\"wp-block-paragraph\">Part of the explanation is that the 2 year T-note yield reflects an average of short-term rates over its life.\u00a0 But even so, the current rate seems to understate the situation.\u00a0 I think that the rest of the explanation can be found here:<\/p>\n\n\n\n<figure class=\"wp-block-image size-full\"><img decoding=\"async\" width=\"1100\" height=\"584\" data-src=\"\/campus\/wp-content\/uploads\/sites\/2\/2021\/12\/Reverse-repo.png\" alt=\"Reverse Repo Chart\" class=\"wp-image-115847 lazyload\" data-srcset=\"https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2021\/12\/Reverse-repo.png 1100w, https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2021\/12\/Reverse-repo-700x372.png 700w, https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2021\/12\/Reverse-repo-300x159.png 300w, https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2021\/12\/Reverse-repo-768x408.png 768w\" data-sizes=\"(max-width: 1100px) 100vw, 1100px\" src=\"data:image\/svg+xml;base64,PHN2ZyB3aWR0aD0iMSIgaGVpZ2h0PSIxIiB4bWxucz0iaHR0cDovL3d3dy53My5vcmcvMjAwMC9zdmciPjwvc3ZnPg==\" style=\"--smush-placeholder-width: 1100px; aspect-ratio: 1100\/584;\" \/><\/figure>\n\n\n\n<p class=\"wp-block-paragraph\"><em>Source: <\/em><a href=\"https:\/\/www.newyorkfed.org\/markets\/desk-operations\/reverse-repo\"><em>Reverse Repo Operations &#8211; FEDERAL RESERVE BANK of NEW YORK (newyorkfed.org)<\/em><\/a><em><\/em><\/p>\n\n\n\n<p class=\"wp-block-paragraph\">The chart above shows the amount of money being accepted each day for reverse repos by the New York Fed.&nbsp; Yesterday\u2019s level was a record.&nbsp; Remember that reverse repo activity is a way of draining liquidity.&nbsp; Quite simply, there is a record amount of cash \u2013 about $1.6 trillion &#8212; sloshing around the system, seeking the risk-free 5 basis points offered by the Fed.&nbsp; Until that flow of funds is substantially reduced, we are likely to see the apparent distortions in short-term rates that we see now.&nbsp; Remember, even with an accelerated taper, the Fed is still buying bonds in the open market for another 3 months.&nbsp; It seems as though it will take more time than that to work through all the apparent excesses.<\/p>\n","protected":false},"excerpt":{"rendered":"<p>The FOMC&#8217;s statement told us to expect rate hikes, but 2 year yields don&#8217;t seem to be giving that message.<\/p>\n","protected":false},"author":4,"featured_media":0,"comment_status":"closed","ping_status":"open","sticky":true,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":"","jetpack_post_was_ever_published":false},"categories":[15,14700,6,8,9,26,3],"tags":[1826,446,314],"contributors-categories":[13576],"class_list":["post-115833","post","type-post","status-publish","format-standard","category-fixed-income","category-ibkr-market-insights","category-north-america","category-region","category-securities","category-text-articles","category-traders-insight","tag-bond-market","tag-federal-reserve","tag-fomc","contributors-categories-interactive-brokers"],"pp_statuses_selecting_workflow":false,"pp_workflow_action":"current","pp_status_selection":"publish","acf":[],"yoast_head":"<!-- This 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