The Federal Reserve announced a reduction in its bond buying program known as quantitative easing (QE). While bond markets barely budged, stock markets rallied strongly following the announcement. The step back signals the Fed’s confidence that the economy is on firmer footing while at the same time reinforcing its goals to keep monetary policy – in the form of zero interest rates – low for longer. Despite today’s good result, going forward such a transition may still be rocky for financial markets.
The specifics of the plan are here, but the headline is a $10 billion/month reduction in purchases of Treasury bonds and mortgage-backed securities.
What does this mean?
- Not a big shock. This won’t be a big shock for bonds, because there’s still plenty of “easy money” in the global financial system as the Fed promised again today. That’s not to say interest rates won’t move higher over time. We are looking for the 10-year U.S. Treasury to end the year higher by around 50 basis points (0.5%) on the back of stronger growth next year.
- Low for Longer. It’s important to note that while the bond-buying program will be slowed, to avoid negative economic consequences of a sharp rise in rates, the Fed will likely keep the short-term fed funds rate low for an extended time. This is the “sugar” in the Fed’s communications.
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