Bond Rally Feeds Off Fed Rate Cut

September 20, 2019

Many investors believe Fed Chairman Powell delivered the best performance of his tenure at Wednesday’s post-FOMC presser. The central bank head treaded a fine line, appeasing both monetary policy doves and hawks without committing to a set course for future monetary policy actions.

Financial markets were calm after the Fed’s 0.25% cut—the second of the year—which is an improvement from recent meetings, when markets often threw tantrums when they saw Powell as insufficiently dovish.

Careful to avoid upsetting the markets, Powell said the Fed would take strong steps to stimulate the economy, if the data warrants it: “If the economy does turn down, then a more extensive sequence of rate cuts will be appropriate.”

But he also accommodated those who believe the economy is so strong it doesn’t need any stimulus. Powell said he does not foresee a recession, and that economic growth should continue at a steady pace, despite trade head winds.

Steady As She Goes

In the aftermath of the Fed rate decision, stocks are back near record highs, with the S&P 500 around 3,000, less than 1% from its peak. The SPDR S&P 500 ETF Trust (SPY) is up 21.6% year to date.

Meanwhile, bonds are holding relatively steady since the Fed decision. The U.S. 10-year Treasury last traded around 1.78%, up from the recent low of 1.43%, but still down substantially from the 2.68% level it started the year.

Likewise, the 30-year Treasury yield is up from the record-low 1.9% set in August to last trade at 2.23%, but it is well below the 2019 starting level of 3.01%.

Importantly, the two-year was last trading at 1.75%, about 3 basis points less than the 10-year, meaning there is no inversion for that part of the yield curve.

 

Treasury Yields

 

Impressive Bond ETF Returns

Though up from their lowest levels of the year, bond yields are still at depressed levels, by any measure. That’s keeping fixed income ETFs well-supported with impressive returns.

The iShares 7-10 Year Treasury Bond ETF (IEF) is up 8.63% this year; its longer-term brother fund, the iShares 20+ Year Treasury Bond ETF (TLT), is up 17.52%.

Fed Chairman Powell mentioned that weak global growth was keeping interest rates overseas exceptionally low, which in turn affects U.S. rates.

“There’s this large quantity of negative-yielding and very-low-yielding sovereign debt around the world, and inevitably that’s exerting downward pressure on U.S. sovereign rates without really necessarily having an independent signal,” Powell said.

That means Treasury ETFs could maintain their gains, even if, as the Fed expects, U.S. growth remains solid.

 

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