By Don Miller
The “flight to quality” continued yesterday (Wednesday) as investors pushed up the price of Treasuries on fears the U.S. Federal Reserve’s drastic rate cut means the economy’s woes are far from over.
But while Treasury prices hit record highs, concerns surfaced among analysts about how much farther the rally can go considering the implied message in the Fed’s statement that the economy is in worse shape than we thought and policy makers will do anything they can to keep it from completely tanking.
"Everyone originally was very enthused yesterday because the Fed made it known they were going to stand and do anything that is necessary, no matter what, to get this economy back on track," said Sal Arnuk, co-manager of trading at Themis Trading in Chatham, New Jersey. "This morning we awaken with a hangover and the realization of how many bullets do they have left?"
Long term Treasuries with 10- and 30-year maturities were favored by investors after the Fed said it would keep long-term interest rates suppressed for “some time.” In its statement the central bank vowed to buy agency and mortgage-backed securities and said it will consider purchasing government debt.
Yields on the 10- and 30-year notes tumbled in New York trading, touching their all time lows, according to BGCantor Market Data, as investors continued to bid up prices.
And for the second straight day, investors in the shortest government securities were willing to accept a negative return for the safety of U.S. government debt, as yields on one-month T-bills reached minus 0.02%.
But the Fed’s latest statement has raised doubts about its real intentions with some analysts. Even though the central bank promised to purchase treasuries to keep interest rates from rising, policy makers will likely avoid purchasing government debt, according to RDQ Economics LLC.
“This step is still an unlikely one for the Fed to take, since it is trying to narrow the spread between mortgage-backed securities and Treasuries,” John Ryding and Conrad DeQuadros, founders of New York-based RDQ, wrote in a note yesterday.
30-year mortgage bonds issued by Fannie Mae (FNM) currently yield 1.49 percentage points more than the benchmark 10-year Treasury note, down from 1.62 percentage points Tuesday. The Fed wants to drive those yields down to encourage borrowers and lenders.
More skepticism comes from the rates themselves. After all, how many investors can tolerate a negative return on their money, when the very nature of investing says they will eventually demand a respectable return?
History is another factor leading some investors to conclude that the Treasury rally is overdone because yields simply can’t fall much further. For instance, the 10-year Treasury currently yields around 2.5%, despite an average of 6.91% since 1962.
Then there are those who see the Fed’s move to cut rates to virtually zero as validation of the market’s valuation of short-term credit. Treasury markets had already breached the Fed’s previous Federal Funds target of 1% before Tuesday's move to cut that target to 0% to 0.25%
“Short-term interest rates have been falling sharply since the financial markets went into a tailspin in September. With Tuesday’s announcement the Fed was essentially acknowledging that it can’t control interest rates any more,” said John Schoen a Senior Producer at MSNBC.
That may be speculation, but the Fed was indeed conspicuous by its absence in the open markets early Wednesday.
According to Reuters, the Federal Reserve of New York said the U.S. central bank had refrained from any open market operations on Wednesday. Typically the New York Fed conducts open market operations at 9:30 a.m.
The regional Fed conducts open market operations for the central bank system. The Fed normally supports its monetary policy by executing short-term purchase and reverse repurchase agreements to influence day-to-day trading in the Federal Funds market.
Federal funds, the benchmark overnight lending rate to banks, last traded at 0.0625%, within the Fed's new target range of zero to 0.25%.
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