The Bond Market Can “Fight the Fed” (And Sometimes Win)

Alan ReynoldsA favoriteWall Street Journal columnist,James Mackintosh, quotes an economist saying that because the price ‐​earnings ratio for stocks rises when bond yields fall, “The most capitalist valuation metric in the world, the P/E of the S&P 500, is now just completely dominated by monetary policy. ”That would make sense if increases in the Fed ’s policy rates were matched by increases in 10‐​year bond yields. On the contrary, bond yields have instead fallen from 3.49% on June 14 when the fed funds rate was 0.33 to 2.78% on August 10 when the funds rate has risen to 2.32%.The red line in the graph shows how the spread between the yield on 10 ‐​year bonds and the rate on overnight fed funds has now narrowed to the point where that key yield curve is nearly inverted—something that has never happened without a recession in the near future.The blue line shows the interest rate the Fed pays to banks as a  reward for holding reserves at the Fed. Since the IOR is set 10 basis points below the top fed funds rate, the blue line also shows when the FOMC raised the funds rate.Another thing that never happened was a  postwar recession in which the Fed did not cut the federal funds rate. In 1980, for example, the Volcker Fed slashed the fed funds ratefrom 19.9% in early April to 8.6% by early June—a record rate cut never matched before or since (and often wrongly ascribed to “the late seventies” by revisionist monetary historians).In fact, the Fed t...
Source: Cato-at-liberty - Category: American Health Authors: Source Type: blogs