As the U.S. inflation data indicated as much as 2.8% of growth in the producer price index (PPI) last Friday, which is the highest value since November 2018, some part of the market seem to be mystified by the possible backlash by the Federal Reserve (Fed) at its latest regular meeting. The results of Fed's own monetary policy's audit will be represented to the market at 18.00 GMT, and the press conference with the U.S. regulator's Chairman Jerome Powell will follow half an hour later.
This possible increase in inflation could be due to the intense work of the U.S. Dollar "printing press", which was set in motion in order to cope with a pandemic disaster, along with the accelerating pace of economic recovery right now, which are considered to be the two main reasons for the repeating spikes of Treasury bonds' yield. Friday's set of data, and further market developments this week, have brought yields to levels above 1.65% per annum on 10-year bonds, which in practice equalled the levels last seen a week before the announcement that the dangerous virus began to spread.
Panic-imposed purchases of guaranteed-income assets during the most part of 2020 made repayments on fresh U.S. debt issues extremely cheap and attractive for the Treasury, but now it seems to have met the end of a free ride. Of course, no one wants to pay more interest for new trillions of public debt, but is there any effective way to break the fever of higher yields? If just a few market participants agree to make new investments into the U.S. debt at a small interest rate? No market fear means no cheap money for the United States anymore.
Market surveys are increasingly suggesting that the Federal Reserve could go ahead with an even larger Treasury bonds’ repurchase, in order to support the demand thus probably reducing the premium requirements of ordinary investors when normal funds or bankers are dealing with such debt-buying activities. This could indeed lead to a temporary peak in the yield charts, which in turn would briefly accelerate the flow of capital into Treasury bonds. But first of all, once yields fall for a while, demand for lower-yielding securities could soon drop as well. Secondly, the additional amounts of purchasing treasury bonds must go somewhere, and in the modern conditions of the United States, they could only be printed too. By doing this, the Fed would only dilute the already blurred Dollar-denominated money supply, which may later spur inflation again, and cause a new jump in yields of Treasury bonds.
Therefore, such a method of solving problems may rather seem absurd, since it could be said to resemble an attempt to put out a small fire with daily doses of gasoline. After the whole series of strange events that have already globally occurred over the past 12 months, it is no longer possible to rule out new absurd solutions, but still it is at least difficult to consider it as a basic and logical scenario. In addition, so far, the speeches of all the representatives of the Federal Reserve have never included the sounds of excessive anxiety about bond yields, and maybe they will prefer just not to escalate market fears this time also. In the beginning of March, Jerome Powell said the recent spike in U.S. bond rates was something "notable and caught my attention," but he added the central bank is unlikely to step up its pace of bond buying. "For asset purchases, they'll continue at least at the current level, until we achieve substantial further progress toward our [inflation] goals. That's actual progress, not forecast progress."
Mr Powell also remarked that time: "There's good reason to think we'll begin to make more progress. But even if it happens, it's likely to take some time to achieve substantial further progress, or interest rates to raise interest rates above zero." Earlier, the Fed also expressed its full readiness to allow higher inflation periods beyond its 2% target "for some time". But nobody or the Fed was saying they want to boost inflation artificially when it is already growing well. But more bond buying would move inflation spikes just nearer. If so, the Fed may feel troubled to follow its own forward guidance at the "dot plot" of Fed officials’ rate expectations, which did not reflect any earlier tightening of policy with no rate hikes until the very end of 2023. And the rise in bond yields in recent weeks did not imply market expectations of an earlier Fed's rate hike move. Bonds yield rather seem to mirror inflation worries, while the path taken by the Fed's rate is seen to be going in its own parallel course.
One way or another, the immutability of the parameters of the Fed's monetary policy is the most likely outcome of today's meeting. In the case of an increase in the asset purchase program, Wall Street has nothing to worry about, as it will most likely get the chance to absorb more money for the same period of time. So it is unlikely that any policy change on this issue may be seen as a threat to the stock market, which may prevent the emergence of new historical records on the S&P500 index or on the Dow Jones Industrial Average index.
The new volumes of Fed's quantitative easing may play a dirty trick on the Dollar exchange rates only in the Forex market, as any additional money supply has nothing to do with a desire to buy and hold more U.S. Treasuries in the investment funds’ portfolios. Even this clear effect is more likely to manifest itself in the medium term, and not necessarily as an immediate reaction to such Fed's decisions. The major currency pairs such as EUR/USD, AUD/USD or GBP/USD may first look at whether Treasury yields continue to rise after the Fed's meeting, but this does not mean that higher yields would excite investors to buy the Greenback.
Yes, the Dollar may find a chance to rebound slightly just as a direct response to the non-expansion of the Fed's asset purchase program. But it is not granted at all, as such a scenario fundamentally means just a freeze of the status quo. As a result, if the bonds' sell-off continues to be accompanied by new spikes in yields, most investors may realise that they have no reason to rush to buy bonds. After all, the later the action of buying is completed, the higher the annual return is thought to be. So, if this week does not end with the remarkable growth for the Dollar, then next week and the end of March may be a time of large-scale weakening for the U.S. currency again.
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