When former Federal Reserve vice-chairman Alan Blinder warned of the dangers of a “cacophony of voices” from interest-rate setters, he might have been thinking of this week’s Fed announcements.
The Fed forecast that it would keep rates on the floor to the end of 2014, 18 months longer than it had previously said. Investors rushed to buy Treasury bonds, driving the yield on the five-year bond to its lowest ever. Then for the first time the Fed revealed individual policymaker forecasts. More expected rates to rise earlier, or later, than in 2014. Yields jumped again.
Investors are now pricing in a rapid tightening in 2015 and 2016, of about 1.5 percentage points each year. Only three times in the past 40 years has the Fed raised faster: 1973-74, 1978-82, and 1989. All were followed by recession.
The Fed also unveiled policymakers’ views on what counts as normal “longer-run” rates, ranging from 3.75-4.5 per cent. With 30-year bond yields at 3.1 per cent, investors seem to expect the economy to remain subnormal for decades.
It is not unreasonable to think that the US will grow more slowly in future, thanks to its debt overhang and the costs of its ageing population.
But lower long-term yields also result from Operation Twist, under which the Fed sells short-dated bonds in favour of longer-dated ones. Perhaps we should be sceptical about indicators from the manipulated bond market.
Still, signs of cheer from the bond market are faint, at best. The 30-year has risen a little recently, but the steepening of the yield curve has mainly been owing to falling five-year rates, which is not a good sign.
By forcing down rates for longer and longer, the Fed is making it progressively less appealing to hold safe assets. That sharpens the distinction between the loss after inflation on safe assets, and the trade the Fed wants: borrowing to take risk. Barring eurozone implosion, risky assets have gained appeal. For a while.
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