Markets

Lisa Abramowicz is a Bloomberg Gadfly columnist covering the debt markets. She has written about debt markets for Bloomberg News since 2010.

Bond traders have been pessimistic about the world for months. In a rapid turn of events, the Federal Reserve has come to agree with them to some degree.

On Wednesday, the central bank largely threw in the towel on its optimism that the U.S. economy can maintain its steam without the help of growth in almost any other part of the world. Fed members significantly reduced their forecasts for U.S. expansion at their meeting this week, lowering their expectations to only two interest-rate increase this year, compared with four at earlier meetings.

Welcome Weakness
The dollar plunged after the Fed indicated that it wouldn't raise rates as much as expected
Source: Bloomberg

Debt investors responded swiftly. They raced back to the same Treasuries that they had sold leading into this meeting, with their economic concerns ratified by the Fed's latest message.

Crestfallen
Bond traders piled back into Treasuries after the Fed downgraded its economic projections
Source: Bloomberg

So what changed? Mainly, the global economy appeared to weaken, eating into the U.S.'s potential by causing the dollar to strengthen, hampering the nation's exports and dampening inflation worldwide. This isn't new, of course. Economists around the world have been steadily ratcheting back their growth expectations over the past few years.

Policy makers also seemed to intensify their focus on recent market volatility, which they worry will make it tough for companies to borrow on the cheap. Fed Chair Janet Yellen even sounded like a credit trader at one point, talking in her statement about the extra yield over benchmark rates that investment-grade companies have been shelling out to borrow. But she also noted that any increase has been offset by lower benchmark rates.

Brief Expense
While borrowing costs briefly rose for U.S. investment-grade companies, they've recently declined
Source: The BofA Merrill Lynch US Corporate Index

Credit markets have been volatile for months, and U.S. inflation has been ticking up. Yellen indicated that the job market continues to improve. These have been some of the Fed's main objectives, but they are apparently being balanced by the central bank's broader worldview.   

The biggest change has been developments in Japan, where central bankers initiated negative interest-rate policies in January, and in Europe, where policy makers just threw the kitchen sink at credit markets by saying they would start to buy corporate bonds in addition to their government-debt purchases and negative rates.

These regions are in a bad spot, which perhaps explains their increasing desperation to ignite some inflation. In Yellen's press conference on Wednesday after the release of the Fed statement, she said that "Japanese growth in the fourth quarter was negative, that was something of a surprise'' and that there was "slightly weaker growth" in the euro zone.

In response to a question by Bloomberg Television reporter Erik Schatzker, Yellen said that negative-rate policies in Japan and Europe have had "mixed effects," with "some positives and some negatives."

For years, Fed policy makers were able to largely ignore the global economy. The U.S. was the alpha dog, with other nations responding to its actions, not the other way around. Now, the U.S. is increasingly at the mercy of the rest of the world. The bond market has realized this for a while. It's nice for the Fed to catch up.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Lisa Abramowicz in New York at labramowicz@bloomberg.net

To contact the editor responsible for this story:
Daniel Niemi at dniemi1@bloomberg.net