Tuesday, November 2, 2021
When Turkey cut interest rates last month, it was the 1000th interest rate cut since Lehman Brothers collapsed in 2008, according to analysis by Bank of America. Moreover, since then, central banks globally have bought over $23 trillion of assets to help support financial markets. Now, with many major developed economies recovering from the COVID-19 shutdowns and inflationary pressures remaining stubbornly high, central bankers are likely going to start to reduce monetary accommodation over the next few years. As central bankers start to reverse course though, markets are aggressively reacting to hawkish surprises that are seen coming out of central banks.
“Interest rate volatility has definitely picked up,” noted LPL Financial Fixed Income Strategist Lawrence Gillum. “When fixed income markets are surprised by hawkish central banks, we’re seeing price action in some interest rate markets that is akin to equity markets–not developed sovereign interest rate markets.”
As seen in the LPL Research Chart of the Day, yields on 2-year Australian (orange line) and Canadian government bonds (light blue line) spiked higher last week when central banks in those countries turned surprisingly hawkish. For Canada, the Bank of Canada abruptly ended its bond purchasing programs and said interest rates would likely need to rise earlier in 2022 than markets were expecting. For Australia, the Reserve Bank of Australia (RBA) failed to defend its yield target, which is part of the RBA’s targeted program to keep interest rates low and is set at 0.1%. That the RBA allowed yields to move dramatically higher was seen as a sign that tighter monetary policy was coming. Those actions (or inactions as was the case by the RBA) surprised markets and bonds sold off dramatically.
Now, the Federal Reserve (Fed) is on the clock. At this week’s Federal Open Market Committee (FOMC) meeting, the Committee is expected to announce plans to begin to reduce its bond purchase programs beginning this month or mid-December. Markets are expecting the Fed to announce a $10 billion a month reduction in Treasury security purchases and a $5 billion a month reduction in mortgage security purchases. The full tapering process is expected to last eight months after which, we think, the Fed will pause before interest rate hikes are considered. Meaningful deviations from that message may negatively impact markets like we’ve seen elsewhere. As the chart above shows, yields on 2-year U.S. Treasury securities (blue line) have inched higher over the past month but have not seen the type of move that was seen in other markets. We attribute that to the deliberate communication strategy by the Fed seemingly telegraphing its intentions months in advance. The last time the Fed was in this position (2013), though, markets were surprised by its hawkish shift. We think the Fed learned its lesson from that episode but a surprisingly hawkish statement by the Fed on Wednesday could result in a dramatic selloff in U.S. Treasury securities as well.
This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors or will yield positive outcomes. Investing involves risks including possible loss of principal. Any economic forecasts set forth may not develop as predicted and are subject to change.
References to markets, asset classes, and sectors are generally regarding the corresponding market index. Indexes are unmanaged statistical composites and cannot be invested into directly. Index performance is not indicative of the performance of any investment and do not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results.
Any company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services. LPL Financial doesn’t provide research on individual equities. All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.
All index and market data from FactSet and MarketWatch.
This Research material was prepared by LPL Financial, LLC.
Insurance products are offered through LPL or its licensed affiliates. To the extent you are receiving investment advice from a separately registered independent investment advisor that is not an LPL affiliate, please note LPL makes no representation with respect to such entity.
- Not Insured by FDIC/NCUA or Any Other Government Agency
- Not Bank/Credit Union Guaranteed
- Not Bank/Credit Union Deposits or Obligations
- May Lose Value
For Public Use – Tracking # 1-05208285