by Blaine Dickason
Vice President, Trading and Fixed Income Portfolio Management
When the Federal Reserve cut their overnight policy rate by a total of 2.0 percent to the zero bound in the fourth quarter of 2008, few investors would have anticipated it would be another seven years before the Fed felt economic conditions warranted raising that policy rate by even one-quarter percent. Fast-forward to March of 2020, when the Fed cut rates by 1.5 percent also to the zero bound, and we can once again speculate on how long interest rates will remain this low.
At their recent September meeting, the policy-setting Federal Open Market Committee issued firm guidance regarding their goals for this recovery. They included the attainment of maximum employment and a new average inflation target of 2 percent. It might feel like a lifetime ago but the unemployment rate in January of this year was just 3.6 percent. Based on September’s unemployment rate of 7.9 percent, the Federal Reserve’s policies will almost surely remain stimulative for some time.
The Federal Reserve sets the overnight interest rate while the market is in firmer control of longer rates, especially for 10 years and beyond. The yield on the 10-year U.S. Treasury climbed to nearly 0.80 percent earlier this month based on increased expectations for additional fiscal stimulus as well as desirable return of inflation expectations. While the development of a successful COVID-19 vaccine will certainly be stimulative, the recent uneven employment recovery coupled with the current weak aggregate demand will likely keep the longer-dated yields from moving up too quickly.
The Federal Reserve has publicly advocated for a strong fiscal stimulus package from Congress; however, they still maintain a significant quantity of dry powder in several of their credit facilities meant to support financial conditions. Just this week they provided an update to the bond purchase programs they announced in March to support corporate liquidity. Of the $250 billion authorized for bond buys in the secondary market, they have thus far only spent $12.7 billion with two-thirds of that purchasing credit-based ETFs. In a clear example of “Don’t Fight the Fed,” you can see fund flows into fixed income have been extremely strong, following the Fed’s own purchases. Regardless of the final amount that get spent from these programs, it is providing significant support to credit markets that should also keep yields and corporate spreads contained.
Source: Evercore ISI
As we have seen firsthand this past year, the Federal Reserve has committed to keeping short-term interest rates extremely low. Heightened economic uncertainty has kept longer rates suppressed. Even considering our hope for the successful development of a COVID-19 vaccine, it will likely still take considerable time to reverse the economic damage wrought by the pandemic. In this environment, we see bond yields remaining historically low.
Week in Review and Takeaways:
Retail sales reported this morning were up 1.9 percent from the prior month and nicely ahead of expectations, partly driven by strong clothing sales during a unique Back-to-School shopping season
The S&P 500 was up 0.2 percent this week