(Bloomberg Opinion) -- Bond traders were spot on in pricing the Federal Reserve’s dovish pivot earlier this year.
Benchmark Treasury yields rose just slightly after minutes of the Federal Open Market Committee’s January meeting were released on Wednesday, perhaps because they had fallen a bit too far. Otherwise, just about everything in the document confirmed the drastic dovish tilt. Many officials said they were unsure about what interest-rate moves might be necessary this year, supporting the idea that the Fed is at least on hold for the foreseeable future and that the next move could be a cut or an increase. What’s more, almost all of them wanted to halt the central bank’s balance-sheet runoff later this year. Here’s a key passage:
Almost all participants thought that it would be desirable to announce before too long a plan to stop reducing the Federal Reserve’s asset holdings later this year. Such an announcement would provide more certainty about the process for completing the normalization of the size of the Federal Reserve’s balance sheet. A substantial majority expected that when asset redemptions ended, the level of reserves would likely be somewhat larger than necessary for efficient and effective implementation of monetary policy; if so, many suggested that some further very gradual decline in the average level of reserves, reflecting the trend growth of other liabilities such as Federal Reserve notes in circulation, could be appropriate.
On top of that, policy makers acknowledged the financial markets and the signals that falling risk-asset prices send about the outlook. As I’ve said before, the market appeared to throw a tantrum over Fed Chairman Jerome Powell’s remarks that the balance sheet was on “automatic pilot.” Well, officials are paying attention now:
Market participants appeared to interpret FOMC communications at the time of the December meeting as not fully appreciating the tightening of financial conditions and the associated downside risks to the U.S. economic outlook that had emerged since the fall. In addition, some market reports suggested that investors perceived the FOMC to be insufficiently flexible in its approach to adjusting the path for the federal funds rate or the process for balance sheet normalization in light of those risks. The deterioration in risk sentiment late in December was reportedly amplified by poor liquidity and thin trading conditions around year-end.
Some traders suggested the minutes weren’t as dovish as expected because Fed officials said that the labor market expanded “strongly” and that household spending growth “remained strong.” Those are just facts, and it’d be silly to expect central bankers to alter their view of economic data to fit their desired interest-rate path. Those positives were countered by comments about moderating business investment and slowing global growth, particularly in China and Europe.
Maybe the market was expecting the Fed to declare that the current fed funds rate is the highest it’ll go in this tightening cycle. That seems like wishful thinking, considering that the most recent “dot plot” from December was forecasting two additional hikes in 2019. Policy makers probably can’t get the market on board with boosting rates twice this year, but they could still do one. And they’re surely going to preserve that option as long as they can.
Treasuries were largely priced for these minutes, and that’s not particularly exciting. Indeed, the yield-curve-inversion trade didn’t come roaring back — at least not yet. The two-year Treasury yield is hovering right around 2.5 percent, the upper bound of the current fed funds rate, which makes sense given the central bank’s on pause but could possibly raise its benchmark one more time. The 10-year yield is 15 basis points higher at 2.65 percent, which is right in line with the average spread between the two maturities in 2019.
The world’s biggest bond market, in other words, is trendless, range-bound and boring. That may be no fun for rates traders and strategists, but it’s probably just fine with the Fed.