FOMC Minutes – Why are bond yields refusing to believe the Fed on interest rates?

fomc FOMC Minutes   Why are bond yields refusing to believe the Fed on interest rates?

ON 17 March, the Federal Open Markets Committee or FOMC of the US, held the Fed rate below 0.25% and sustained the bond buying program. However, bond markets were far from convinced.

What the FOMC said

In a way, the FOMC reiterated the long-term monetary view that it had outlined in August 2020. It decided to hold rates at 0.00%-0.25% till growth bounced back and the ill-effects of COVID were fully eliminated. In terms of time lines, the Fed has almost assured that it will not tinker with rates till the end of 2023. The Fed also assured that bond buying would continue at $120 billion/month and even increase if the situation called for. In addition, the Fed would not just focus on absolute inflation number but sustained average inflation and that had to remain above 2.2% for a long period.

FOMC tries to belie fears

FOMC meet on 17 March was crucial as it was coming in the background of one of the sharpest rallies in US bond yields. The 10-year benchmark yields rallied from 0.51% to 1.74% giving a hint that the Fed may not be able to hold rates low despite its best intentions. Hence, the primary goal of the FOMC on 17 Mar was to ensure that this fear was belied by giving a long-term trajectory of rates and the liquidity program. That is what the FOMC has tried to do with language that was emphatic and persuasive.

Bond markets are unconvinced

Two days after the FOMC policy was announced, the bond yields continued to rally. For example, the 10-year bond yields in the US rallied to 1.75%, while the 30-year bond yields crossed 2.5% after a very long time. The bonds have found some real anomalies in the FOMC statement. Firstly, the statement has spoken about a sharp rebound in GDP growth of over 6% in CY22. However, despite inflation at 1.7% already, the Fed appears to be confident of reining inflation within 2.2%. Bond markets feel that is not feasible. Secondly, traders believe that when it comes to a choice between growth and price stability, the Fed may have no choice but to opt for price stability later this year.

Pace of bond buying

Bond markets have also had doubts that the Fed will not be able to sustain the $120 billion bond buying program for too long. The Fed balance sheet has now jumped to $8 trillion and the bond markets are of the view that such rapid pace of balance sheet expansion by the US Federal Reserve cannot be sustained for too long. Clearly, we have a case for the first time where the Fed has been emphatic about rates and liquidity but the bond markets in the US are not really convinced. That is not great news for Indian markets as the domestic rally will depend largely on how quickly the bond yields in the US trend lower.

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