Why the Fed is the key to mixed bond market signals

Bonds 5 minutes to read

Althea Spinozzi

Fixed Income Specialist, Saxo Bank

Summary:  Today's Federal Open Market Committee meeting is critical for investors , given the huge influence of Fed policy on asset valuations worldwide. But what should bond investors watch out for in particular?

This week is a busy one with 14 central banks making monetary policy decision. The lion’s share of the bond market’s attention will go to the US Federal Reserve, where traders from around the world are looking to understand whether their positioning on corporate bonds and emerging markets was the right course of action amidst sluggish global economic growth.

The financial market is giving us conflicting messages: both the bond market and the equity market have been rallying since the selloff in equities at the end of last year. The yield on the 10-year Treasury yield, long regarded as a safe haven, has been falling from its high of 3.2% at the beginning of November to 2.55% at the beginning of January; since then it has been trading rangebound with a tendency to the bottom of the channel. 

In the meantime, the S&P has risen 16.5% from the beginning of the year, leaving many to wonder whether the bond market knows something that equities don’t. 

The rally seen since the beginning of the year was provoked by a radical pivot from hawkish to dovish at the word’s major central banks. The chart below shows that the rally began in earnest on January 4, when Fed chair Jerome Powell said that the Fed will be patient with monetary policy, suggesting that will not continue to hike interest rates at the pace outlined a month earlier.
Source: Saxo Bank
Fed policies do not only drive the valuation of dollar-denominated debt, but also support the valuation of risky assets worldwide, such as emerging markets and lower-rated corporates. This is why today’s Federal Open Market Committee meeting today is receiving so much attention. A dovish Fed means the difference between resilient markets and a widespread sell-off that hits the weaker parts of the economy disproportionately.

Today, we expect the Fed to keep interest rates unchanged until data show that the macro environment is well supported. The element of surprise this week concerns possible news on the ending of the balance sheet runoff. We believe that the Fed will take some time before revealing when is going to terminate its quantitative tightening, as that could provoke a contained sell-off in equities, EM and corporate bonds. However, if it decides to outline a plan to end its balance sheet runoff, we may witness to a last push higher in equities, EM and credits.

It has not been easy for fixed income investors to find buying opportunities in the credit space of late, but if the Fed does not announce the end of QT, or if the announcement is disappointing, this might me the perfect time to buy bonds amid a contained sell-off. 
We believe that with central banks staying supportive of the economy (against a looming recession threat), quality bonds will continue to rise in value; lower-rated credit, meanwhile, might rise in the short-term, but will be doomed to sensibly reprice as a recession approaches. 

This is why we recommend investors remain cautious and not take on unnecessary risk unless the fundamentals look particularly promising. But what should if the Fed is complacent regarding market expectations and outlines and end of QT, boosting asset valuations?

US two-year Treasury notes are trading at 2.45%, 5 basis points lower than the Federal Reserve benchmark rates, suggests that the market is indeed positioned for a more dovish message. Thus, current credit spreads could be poised to tighten further from here.
If this is the case, investors will have their hands tied as current valuations will most likely rise until the economy begins to enter into a recession. Still, this should not be an excuse to refrain from putting one’s money to work, particularly when the US yield curve offers good returns. Even parking some money in one- and two-year maturities will return more than 2%, and in the meantime investors will have all the time in the world to make up their minds.

Related Articles


Saxo Capital Markets (Australia) Pty Ltd prepares and distributes information/research produced within the Saxo Bank Group for informational purposes only. In addition to the disclaimer below, if any general advice is provided, such advice does not take into account your individual objectives, financial situation or needs. You should consider the appropriateness of trading any financial instrument as trading can result in losses that exceed your initial investment. Please refer to our Analysis Disclaimer, and our Combined Financial Services Guide and Product Disclosure Statement. All legal documentation and disclaimers can be found at https://www.home.saxo/en-au/legal/.

The Saxo Bank Group entities each provide execution-only service. Access and use of Saxo News & Research and any Saxo Bank Group website are subject to (i) the Terms of Use; (ii) the full Disclaimer; and (iii) the Risk Warning in addition (where relevant) to the terms governing the use of the website of a member of the Saxo Bank Group.

Saxo News & Research is provided for informational purposes, does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. No representation or warranty is given as to the accuracy or completeness of this information. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. No Saxo Bank Group entity shall be liable for any losses that you may sustain as a result of any investment decision made in reliance on information on Saxo News & Research.

To the extent that any content is construed as investment research, such content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication.

Please read our disclaimers:
- Full Disclaimer (https://www.home.saxo/en-au/legal/disclaimer/saxo-disclaimer)
- Analysis Disclaimer (https://www.home.saxo/en-au/legal/analysis-disclaimer/saxo-analysis-disclaimer)
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)

The Saxo trading platform has received numerous awards and recognition. For details of these awards and information on awards visit www.home.saxo/en-au/about-us/awards

Saxo Capital Markets (Australia) Pty Ltd ABN 32 110 128 286 AFSL 280372 (‘Saxo’ or ‘Saxo Capital Markets’) is a wholly owned subsidiary of Saxo Bank A/S, headquartered in Denmark. Please refer to our General Business Terms, Financial Services Guide and Product Disclosure Statement to consider whether acquiring or continuing to hold financial products is suitable for you, prior to opening an account and investing in a financial product.

Trading in financial instruments carries various risks, and is not suitable for all investors. Please seek expert advice, and always ensure that you fully understand these risks before trading. Trading in leveraged products such as CFDs and Margin FX products may result in your losses surpassing your initial deposits. Saxo Capital Markets does not provide ‘personal’ financial product advice, any information available on this website is ‘general’ in nature and for informational purposes only. Saxo Capital Markets does not take into account an individual’s needs, objectives or financial situation.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the US and other countries. AppStore is a service mark of Apple Inc.

The information or the products and services referred to on this website may be accessed worldwide, however is only intended for distribution to and use by recipients located in countries where such use does not constitute a violation of applicable legislation or regulations. Products and Services offered on this website is not intended for residents of the United States and Japan.
Please click here to view our full disclaimer.