Friday, November 30, 2007

Paradoxical Responses to Fedspeak

Throughout November, the US Treasury bond market seems to have been responding to Fedspeak by going in the opposite direction from what Fed statements would suggest about interest rates. Early in the month, when Fed officials were sounding (to my ears, anyhow) hawkish, interest rates fell. Over the past few days, with Fed officials sounding more dovish, interest rates have risen.

With respect to long-term bonds, this behavior is consistent with a view in which statements by Fed officials give clues about the Fed’s degree of commitment to keeping inflation low. Hawkish statements mean less inflation, which means lower long-term interest rates. Dovish statements mean more inflation, which means higher long-term interest rates.

It’s a bit harder to rationalize the response of short-term bonds (by which I mean 2-year Treasury notes, Treasury bills, and seasoned securities nearing maturity). The Fed’s commitment to keeping inflation low shouldn’t be much of an issue here, because there isn’t enough time for the inflation to develop before the bond matures.

Another explanation is flight to quality: when the Fed is more hawkish, bondholders worry more about the creditworthiness of other borrowers and shift their assets into Treasury securities, causing the interest rates on those securities to fall. But even the Eurodollar market, which is considered more risky than the Treasury market, has been responding in the same direction.

A variation on the flight to quality explanation is that the flight is from stocks: hawkish statements by the Fed cause investors to sell stocks and replace them with bonds, thus causing bond yields to fall. But presumably the reason investors sell stocks is that they think higher interest rates are bad for the stock market. Why would this cause them to bid down interest rates to an even lower level? Once interest rates fall, wouldn’t they immediately go back into stocks?

My best guess about what’s going on is that the bond market thinks it understands Fed policy better than the Fed does. The bond market is convinced that interest rates will eventually have to come down to prevent, or to recover from, a recession. The sooner the Fed starts cutting – the sooner it sets into motion the recovery process – the less cutting it will eventually have to do. In particular, if the Fed cuts sufficiently at the next two meetings, it may be able to avoid a recession. If not, a recession is nearly certain, and more dramatic (and longer lasting) cuts will be necessary to recover from the recession. This is how I imagine that the bond market reasons, but I’m not convinced that the bond market is right.

Labels: , , , , ,

19 Comments:

Anonymous jack said...

The 'flight to quality' is likely equity to fixed income not simply equity to treasury. Even if it were, the proceeds of all those sales have to go somewhere and it will mostly be cash or other maturities or credits which might still mean a steep change in demand and therefore price.

There are explicit asset allocation models out there, in pension funds for example, which mandate some institution, and therefore market, responses.

Fri Nov 30, 11:39:00 AM EST  
Anonymous Karl Smith said...

My guess is that bond holders believe that the channel of monetary policy runs through instruments other than than treasuries.

For example, I would check commercial paper rates against treasuries. Thats one potential non-treasury channel. The prime rate moves lock step with funds rate and so that is another potential channel.

The primary channel probably is willingness to lend to marginal credit borrowers.

Suppose, that the Fed is more hawkish. This implies that marginal credit borrowers will find a harder time getting loans. This may imply lower utilization rates and hence lower profits.

Decreasing profit horizons not necessarily rising discount rates drag down stocks. Expecting the return on stocks to be lower, investors move into treasuries.


In a round about way one could say that the interest rate for the most credit worthy borrowers is determined by the marginal productivity of capital while the interest rate for less credit worthy borrowers is determined by the money supply.

A shrinking money supply can thus imply lower interest rates for the most credit worthy borrowers.

I know you mentioned eurodollars but the risk there is still small compared to a average or poor credit consumer or small business.

Fri Nov 30, 05:54:00 PM EST  
Anonymous Anonymous said...

I just think doves are more interesting than hawks.

Fri Nov 30, 09:54:00 PM EST  
Blogger knzn said...

Karl, I think to make your scenario consistent with my data, people have to be expecting the spread of fed funds over treasuries to widen when the Fed tightens (which seems reasonable by itself) but also expect the spread of LIBOR (eurodollars) over fed funds to narrow at the same time (which doesn't seem reasonable to me) even as the spread of commercial paper over treasuries widens.

Fri Nov 30, 10:40:00 PM EST  
Anonymous jack said...

You can't think of the TED spread as a simple credit thing at the moment. Even if the liquidity squeeze is credit related it has its own dynamic, for example implied overnight rates for December 31 in euros hit 14% this week. It could narrow even with rising corporate credit spreads even without sectoral considerations.

Where do you think the "stitch in time" theory might be wrong?

Sat Dec 01, 06:16:00 PM EST  
Blogger knzn said...

I just think the bond market is overestimating the chance of a recession, and perhaps overestimating the influence of current Fed policy on the outcome. It's hard to justify the current 2-year yield except under the expectation that a recession is a near certainty.

Tue Dec 04, 04:51:00 PM EST  
Blogger BaughSIU said...

knzn i agree with you. not just in the bond market, but within the entire economy. aren't we taught as economists that the economy goes through cycles, ups and downs, highs and lows? we've seen housing and credit crunches before. we have been through an oil crisis (though i wouldnt call this a crisis, we are just getting skewered by the oil companies). it seems that everyone is overreacting to everything that is going on. the fed is doing what it thinks is right, and the natural motion of the economy should fix itself.

Tue Dec 04, 06:16:00 PM EST  
Blogger Brian Faster said...

baugh@siu is completely correct in the skewering we are taking over on these gas prices. I think "bending over" might be a better term though. And with the question about the recession, I don't feel that is a negative thing. Recession for two consecutive negative quarters is not a big issue as people like to make it out to be. It only means that production levels are at a standstill, but not necessarily on a downfall. These situations are predicted for the future and they should always pan out due to the many factors leading up to them. It's a buyers market right now, meaning interest rates are currently low, so it is a good time to invest during this quote unquote recession.

Tue Dec 04, 07:16:00 PM EST  
Anonymous Anonymous said...

It appears that there is indeed a lot of concern over the recession, and I couldn't say whether this behaviour is common when recessions are forthcoming. Perhaps this execssive concern arises because there are so many other issues, like the climate change crisis coupled with steadily increasing global demand for energy, increasing water shortages or water quality issues around the world, and the ongoing Iraq war fiasco. When you add it all up, things are looking pretty bleak, and the recession is just another irritant. We could all be a lot more optimistic if the developed world's middle class and the world's upper classes could simply learn to live with less and politicians were competent enough to address real as opposed to manufactured threats.

Wed Dec 05, 10:05:00 AM EST  
Anonymous Anonymous said...

福~
「朵
語‧,最一件事,就。好,你西.............................................................................................................
..................

Thu Apr 02, 10:38:00 AM EDT  
Anonymous Anonymous said...

酒店喝酒,禮服店,酒店小姐,酒店領檯,便服店,鋼琴酒吧,酒店兼職,酒店兼差,酒店打工,伴唱小姐,暑假打工,酒店上班,酒店兼職,ktv酒店,酒店,酒店公關,酒店兼差,酒店上班,酒店打工,禮服酒店,禮服店,酒店小姐,酒店兼差,暑假打工,酒店經紀,台北酒店,禮服店 ,酒店小姐,酒店經紀,酒店兼差,寒假打工,酒店小姐,台北酒店,禮服店 ,酒店小姐,酒店經紀,酒店兼差,暑假打工,酒店小姐,台北酒店,禮服店 ,酒店小姐,酒店經紀,酒店兼差,寒假打工,台北酒店,禮服店 ,酒店小姐,酒店經紀,酒店兼差,暑假打工,酒店小姐,台北酒店,禮服店 ,酒店小姐,酒店兼差,暑假打工,酒店小姐,台北酒店,禮服店 ,酒店小姐,酒店經紀,酒店兼差,寒假打工,酒店小姐,台北酒店,禮服店 ,酒店小姐,酒店經紀,酒店兼差,暑假打工,酒店小姐,台北酒店,禮服店 ,酒店小姐,酒店經紀,酒店兼差,寒假打工,酒店小姐,台北酒店,禮服店 ,酒店小姐,酒店經紀,酒店兼差,暑假打工,酒店小姐,禮服店 ,酒店小姐,酒店經紀,酒店兼差,寒假打工,酒店小姐,禮服店 ,酒店小姐,酒店經紀,酒店兼差,暑假打工,酒店小姐,禮服店 ,酒店小姐,酒店經紀,酒店兼差,寒假打工,酒店小姐,禮服店 ,酒店小姐,酒店經紀,酒店兼差,暑假打工,酒店小姐,酒店傳播,酒店經紀人,酒店,酒店,酒店,酒店 ,禮服店 , 酒店小姐,酒店經紀,酒店兼差,暑假打工,招待所,酒店小姐,酒店兼差,寒假打工,酒店上班,暑假打工,酒店公關,酒店兼職,禮服店 , 酒店小姐 ,酒店經紀 ,酒店兼差,暑假打工,酒店,酒店,酒店經紀,酒店領檯 ,禮服店 ,酒店小姐 ,酒店經紀 ,酒店兼差,暑假打工, 酒店上班,禮服店 ,酒店小姐 ,酒店經紀 ,酒店兼差,暑假打工, 酒店上班,禮服店 ,酒店小姐 ,酒店經紀 ,酒店兼差,暑假打工, 酒店上班,酒店經紀

Mon Apr 20, 11:00:00 PM EDT  
Blogger Kevin said...

牙醫,植牙,假牙|矯正|牙周病,牙醫診所植牙,紋身,刺青,創業,批發,皮膚科,痘痘,雷射脈衝光除斑,中醫,飛梭雷射,肉毒桿菌,玻尿酸,痘痘,脈衝光,醫美,毛孔粗大,醫學美容,seo,關鍵字行銷,關鍵字自然排序,網路行銷,關鍵字自然排序,關鍵字行銷seo,關鍵字廣告,網路行銷,seo,關鍵字行銷,關鍵字廣告,關鍵字,自然排序,部落格行銷,網路行銷,網路爆紅,牛舌餅婚紗台中婚紗

Thu Apr 23, 02:53:00 AM EDT  
Anonymous Anonymous said...

Do you wannaghd hair straighteners for you own , we have many
cheap ghd hair straightenersin style and great,you can choose one from these
hair straighteners
Authentic chaussure puma
chaussure sport
And chaussure nike shoes
Come here to have a look of our Wholesale Jeans
Many fashionMens Jeans ,eye-catching
Womens Jeans ,and special out standing
Blue Jeans ,you can spend less money on our
Discount Jeans but gain really fine jeans, absolutely a great bargain.
www.crazypurchase.com
China Wholesale
wholesale from china
buy products wholesale
China Wholesalers
http://weddingdressseason.com

Mon Jun 08, 03:34:00 AM EDT  
Anonymous Anonymous said...

There are ed hardy shirts
,pretty ed hardy shirt for men,

ed hardy womens in the ed hardy online store

designed by ed hardy ,
many cheap ed hardy shirt ,glasses,caps,trouers ed hardy shirts on sale ,

You can go to edhardyshirts.com to have a look ,you may find one of ed hardy clothing fit for you
Top qualitymen's jacket,
These cheap jacket are on sale now,you can find
north face jackets inmage on our web

Mon Jun 08, 03:34:00 AM EDT  
Blogger wow power leveling said...

cheap wow gold buy wow power leveling my wow gold cheapest wow power leveling
replica replica rolex
CHEAP wow power level
BUY power leveling
replica rolex replica
cheap lotro gold
replica rolex
CHEAPEST power leveling
cheap rs gold l

Tue Jun 09, 10:22:00 PM EDT  
Anonymous Anonymous said...

クレジットカード 現金化
国内格安航空券
おまとめローン
留学
インプラント
CloneDVD

Wed Jul 08, 02:11:00 AM EDT  
Anonymous Anonymous said...

桜の季節
素敵な音楽
海辺
幸福の路
風景
FX
出会い
mem
人材育成 システム
FrontPage
アクサダイレクト
高級住宅

Wed Jul 08, 02:11:00 AM EDT  
Anonymous Anonymous said...

物語の世界
描く日記
愛車
音楽のある生活
桜の涙
冬の太陽
人材派遣
私の家
sabely
kareny
不動産
合宿免許
新幹線

Wed Jul 08, 02:11:00 AM EDT  
Blogger 2012天氣晴朗 said...

牙醫,植牙,矯正,矯正牙齒,皮膚科,痘痘,中醫,飛梭雷射,毛孔粗大,醫學美容,痘痘,seo,關鍵字行銷,自然排序,網路行銷,自然排序,關鍵字行銷seo,部落格行銷,網路行銷,seo,關鍵字行銷,自然排序,部落格行銷,網路行銷,牛舌餅婚紗台中婚紗,腳臭,腳臭,腳臭,腳臭,腳臭,腳臭,腳臭,腳臭,街舞,小產,雞精,性感,辣妹,雷射溶脂,雙下巴,抽脂,瘦小腹,微晶瓷,電波拉皮,淨膚雷射,清潔公司,居家清潔,牙周病,牙齒矯正,植牙,牙周病,矯正,植牙

Thu Jun 10, 10:49:00 PM EDT  

Post a Comment

Links to this post:

Create a Link

<< Home