The Federal Reserve’s two-day meeting begins today, ending with tomorrow’s announcement that will be widely analyzed for signals on the expected timing of the first interest rate hike since 2006. Some analysts have recently predicted the first hike could come as early as June, but the wobbly economic data of late suggests that the Fed may be inclined to delay the start of a tighter monetary policy. The market once again seems to be embracing the lower-for-longer view, based on the latest run into bonds. After Treasury yields reached 2015 highs earlier this month, rates have pulled back in recent days ahead of tomorrow’s Fed announcement.
Notably, the 2-year Treasury yield—considered to be the most sensitive spot on the yield curve for rate expectations—slipped to 0.66% yesterday (Mar. 16) after touching 0.73% earlier this month, based on daily data from Treasury.gov.
Yesterday’s industrial production numbers certainly didn’t boost confidence that the economy’s accelerating. Although output advanced by a mild 0.1% in February, manufacturing activity contracted for the third month in a row. The soft numbers follow last week’s news that retail sales decreased in February, also for the third straight month.
Meantime, the market’s implied inflation forecast (yield spread for nominal less inflation-indexed Treasuries) has been sliding lately. The decline has been particularly sharp for 5-year maturities, which are currently pricing inflation at 1.27% as of yesterday (Mar. 16), down from 1.61% on Mar. 4.
Given the current climate, it’s no surprise to find that long Treasuries are attracting fresh cash flows lately. Consider the iShares 20+ Year Treasury Bond ETF (TLT), which has popped more than 4% through yesterday’s close (Mar. 16) vs. its intraday low this month (Mar. 6). In fact, as the next chart below shows, TLT (black line at top) has remained the performance leader by a wide margin among US bond ETFs generally over the past year. Although long-dated Treasuries have fallen sharply through much of 2015, the latest rally is a reflection of renewed doubts about the Fed’s willingness to raise rates in the near term.
The question that may or may not be answered in tomorrow’s Fed statement (and Janet Yellen’s subsequent press conference) is whether the still-resilient labor market will continue to persuade the central bank to focus on raising rates at some point in the near future. Quite a lot of attention is focused on whether the Fed will continue to use the word “patient” in its policy statement. Removal will reportedly indicate that a rate hike is drawing closer; by contrast, if “patient” remains in the statement, the crowd will interpret the inclusion as a signal that the first rate hike will be delayed.
Tomorrow’s meeting will also dispense new economic forecasts, which will offer additional context for judging the Fed’s current outlook. For example, in the last set of projections published in mid-December, GDP growth for 2015 was expected to be in the 2.6%-to-3.0% range—unchanged from the previous round of forecasts. Will the Fed pare this estimate in tomorrow’s forecast? With the answer in hand, we’ll be in a much stronger position to judge the outlook on the timing of the first rate hike.