The Fed is Finally Letting the Economy do its Own Thing

Federal Reserve Chair Janet Yellen recently gave a speech, and she indicated that the U.S. economy was healthy. Yellen bad a discussion with Ford School Dean Susan M. Collins at the Gerald R. Ford School of Public Policy. The Fed Chair’s recent comments could be good for Treasury securities over the short term. Now let’s get right into what some of the Fed Chair’s comments during this meeting.

Fed Chair Yellen’s Recent Comments

Now, the Federal Reserve is still planning to raise U.S. interest rates at a gradual pace in order to sustain employment and the 2% inflation target, without shocking the markets. In her speech at the event at University of Michigan’s Ford School of Public Policy, Yellen stated, “I think we have a healthy economy now.”

Yellen also stated, “Looking forward, I think the economy is going to continue to grow at a moderate pace…Our job is going to be to try to set monetary policy to sustain what we have achieved.” Not only that, but the Fed indicated that there would only be two more planned rate hikes this year. Moreover, the Fed is planning to start reducing its largest holdings of some securities by the end of 2017.

According to trader Jason Bond, “The Fed’s current view on the market could actually be good for some Treasury securities, and Treasury bond ETFs in the short term. With only two additional potential rate hikes, and the market’s view of the Fed’s rate hike in March as ‘dovish,’ Treasury bonds ETFs, such as the iShares Barclays 20+ Year Treasury Bond ETF (NASDAQ: TLT), could actually rise.”

Yellen also stated, “Whereas before we had our foot pressed down on the gas pedal trying to give the economy all the oomph we possibly could, now allowing the economy to kind of coast and remain on an even keel -- to give it some gas but not so much that we are pressing down hard on the accelerator -- that’s a better stance of monetary policy.” After this speech, Treasury yield were, more or less, unchanged.

IShares Barclays 20+ Year Treasury Bond ETF in Focus

Now, after Yellen’s comments, TLT actually experienced a strong rise. First, let’s look at the background on this ETF. TLT provides exposure to long-term U.S. Treasury bonds, and it does so by tracking an index that is comprised of U.S. Treasury bonds with remaining maturities of greater than 20 years.

That in mind, since the ETF is exposed to U.S. Treasury bonds with maturities greater than 20 years, it has a higher degree of interest rate risk. In other words, it has a higher duration, in theory, if rates rise 1%, TLT would fall significantly. With the Fed looking to “gradually” raise rates, this has eased some concerns over the short-term.

However, one trader noted, “There’s some complexities with TLT. As rates rise, TLT should fall over the short term. However, over the long term, the fund managers are able to reinvest at a higher interest rate, which could potentially pair off the losses in the short term, as they would be investing at a higher interest rate.”

Moving on, the markets are looking for the Fed to leave rates unchanged in its next meeting. Market participants are placing over a 95% probability that the Fed would leave rates unchanged, according to the CME Group’s FedWatch Tool. Consequently, this may have attributed to TLT’s recent gain. Between April 10 and April 18, 2017, TLT rose by nearly 3%, as some of the interest rate has been taken off the table.

What’s Next

With the Fed meeting on May 3, 2017, market participants should focus on any comments made by Fed voting members ahead of the meeting, and on the day of the meeting, as this could significantly affect the price of TLT. That said, the Fed could say one thing and do the other.