It’s too soon to say if the bond market will stay on board with the Fed’s new world order. From 10 miles up, however, all looks fine, as our chart below suggests. Rates and spreads have both dropped considerably, delivering an upward sloping yield curve along the way. Mr. Bernanke’s big adventure, in short, appears to be on track.
After yesterday’s cut, Fed funds are now at 3.0%, well below the benchmark 10-year Treasury’s 3.78%, as of last night’s close. The decline and fall of the 10-year yield has been fairly steep and swift. Indeed, the yield at one point last June reached as high as 5.23%. After a subsequent loss of nearly 150 basis points, it’s safe to say that a lot’s changed.
Surely no one can misread the central bank’s new strategy of reflating. That may or may not be the ideal prescription, but a hefty dosage is comine just the same. The rate on Fed funds rarely crumbles this far this quickly. And it’s not clear that we’re done. The May ’08 Fed funds futures contract is priced in anticipation of another 50-basis-point cut, which would bring us down to 2.5%.
So far, the bond market has been happy to tag along with the prevailing monetary winds. This is no small point. One can only imagine the chaos that might erupt if the Fed’s aggressive cutting was scaring the heck out of bond investors. In fact, just the opposite has been the norm. One example of the bond market’s vote of support can be seen in the 2.8% rise in the iShares Lehman 7-10 Year Treasury ETF (IEF) this month alone. Since last June, this ETF is up about nearly 15%, which, of course, is an extraordinary run for what’s essentially a risk-free asset if–a big if–in a world where inflation is largely mute.