Dealers Say No End to QE in ’13; 2016 Rate Rise: HatziusDaniel Kruger and Liz Capo McCormick
Wall Street’s biggest bond dealers see little chance the Federal Reserve will slow the pace of debt purchases designed to boost economic growth before the fourth quarter, even as policy makers face calls to curb the buying.
Of the 21 primary dealers that trade with the central bank, 14 said in a Bloomberg News survey that the Fed won’t start to reduce its $85 billion monthly bond buying until the last three months of 2013. Twelve forecast they will end in mid-2014 or later. Fifteen say it will take until at least June 2015 for policy makers to raise the record low benchmark interest rate target of zero to 0.25 percent. Goldman Sachs Group Inc. chief economist Jan Hatzius sees no increase before January 2016.
Fed Chairman Ben S. Bernanke, an academic expert on the seeds of the Great Depression, has pumped more than $2.5 trillion into the economy to fulfill the twin mandates of full employment and price stability. Critics, including officials within the central bank, say the purchases don’t create jobs and risk creating asset price bubbles. The bond market has backed the measures as inflation concerns diminish and investors push Treasury yields to about the lowest this year.
“It’s going to take a long time for the slack in the labor market to be unwound,” Hatzius, who was named one of the 50 most influential people in global finance by Bloomberg Markets Magazine in 2011, said in an April 18 telephone interview from New York. “We have inflation below the target for the next two years. We think they’re still going to be missing on the mandate, and if you’re missing on the mandate you’re going to want to do more.”
The earliest prediction for when the Fed will begin reducing bond purchases is the third quarter of this year by Deutsche Bank AG, while Mizuho Securities USA Inc. sees no tapering for two years. Deutsche Bank and Societe Generale SA estimate the buying will end this December. Bank of Nova Scotia, Bank of Montreal, BNP Paribas and Mizuho predict it will last into 2015.
Hatzius said the Fed won’t be able to raise its target overnight interest rate, which has been zero to 0.25 percent since December 2008, until January 2016. Of the 19 dealers with calls for when the Fed will increase rates, 17 predict it will happen in 2015.
“It’s still too early” to end the bond buying, Rajiv Setia, head of U.S. interest-rate research at Barclays Plc in New York, a primary dealer, said in an April 19 telephone interview. “This is the only tool they have. They’re doing all they can. At the end of the day, the benefits outweigh any risks of a bubble for now.” Barclays forecasts the Fed will slow its pace of purchases in the first three months of 2014 and end them by June next year.
Backers of Fed stimulus point to a sluggish economy. Unemployment was 7.6 percent in March as payrolls grew by 88,000, the least in nine months, according to Labor Department data released April 5. Retail sales fell in March by 0.4 percent, the biggest drop since June, the Commerce Department said April 12. Confidence as measured by the Thomson Reuters/University of Michigan preliminary index of consumer sentiment declined to 72.3 in April from 78.6 a month earlier.
The bond market has become more pessimistic on the economy in the last six weeks. On March 11 the 10-year Treasury yield closed at 2.06 percent, its high for the year, up from 1.76 percent at the end of 2012. It has since fallen as low as 1.68 percent on April 15, the biggest drop since the period from April 27 to June 1, 2012 when it slid 0.48 percentage point to a then record-low 1.45 percent as Europe’s debt crisis worsened.
The 10-year note was little changed to yield 1.71 percent at 9 a.m. New York time, according to Bloomberg Bond Trader prices. The 2 percent note due February 2023 was little changed at 102 20/32.
“We had one poor employment report and a bunch of lousy data thereafter,” said Joseph LaVorgna, chief U.S. economist at Deutsche Bank in New York in an April 18 telephone interview. “Six weeks of this data has gotten the market back on ‘uh-oh, here we go again camp,’ because, to one degree or another, we saw similar slowdowns in 2010, 2011, and 2012. The market has probably gotten way too worried.”
Fed asset purchases risk creating asset bubbles, according to Zach Pandl of Columbia Management Investment Advisers LLC.
“We’re not convinced that the easy policy won’t create serious risks to the financial system over the longer term,” Pandl, a senior interest-rate strategist in Minneapolis for the firm which oversees $340 billion, said in an April 19 telephone interview. “The U.S. economy would be in much worse shape if the Fed had not aggressively eased. But many things have been standing in the way, limiting the impact of the monetary easing going forward.”
Philadelphia Fed President Charles Plosser said in an April 11 speech in Hong Kong the Fed should begin reducing the pace of bond buying, citing the drop in unemployment to 7.6 percent in March from 8.1 percent in August since the start of a third round of asset purchases in September. “We have seen sufficient improvement to begin tapering our asset purchase program with the objective of bringing it to an end before year-end.”
The dealers are holding on to Treasuries. The securities account for 38.5 percent of their debt holdings, excluding state and local government bonds, close to the record 39.8 percent reached in December, Fed data as of April 10 show. The dealers owned $137.9 billion, the most since $145.7 billion on Dec. 19 and the second-highest total going back to 1997.
Investors using borrowed funds to boost returns, so-called leveraged accounts, held a net $56.1 billion in contracts wagering on gains in 10-year Treasury futures in the week ending April 16, data from the Commodity Futures Trading Commission show. That’s approaching the record of $60.3 billion set in the week of April 2, which topped a mark set in August 2007 before credit markets froze and the economy went into recession, sparking a rally in government bonds. As recently as July, there were net bets against the Treasuries.
In a bullish sign for bonds, fixed-income money managers overseeing a combined $130 billion have increased their asset-weighted duration, a reflection of how long the debt they own will be outstanding, to 98.6 percent of target indexes as of April 16 from 97.2 percent on March 19, which was the least since September 2008, according to a survey by Stone & McCarthy Research Associates in Plainsboro, New Jersey.
“The economy is very interest-rate sensitive, so if the Fed cuts its support too early the market would overreact and we would see a spike in yields and a rotation back to slower growth,” Larry Dyer, a U.S. interest-rate strategist with primary dealer HSBC Holdings Plc in New York, said in a telephone interview on April 16. “Slower growth would just mean more Fed, and they know that.”
HSBC expects smaller purchases beginning late this year.
The Federal Open Market Committee’s central tendency forecasts, released after the March 19-20 meeting, are for a jobless rate of 7.3 percent to 7.5 percent in the final quarter of 2013, falling to 6.7 percent to 7 percent a year later. The majority of Fed officials don’t anticipate raising the benchmark interest rate until 2015, according to their estimates.
Bernanke, who published a collection of essays on the Great Depression in 2004, said after the Fed’s March 19-20 meeting that further gains in the labor market were needed before he would consider reducing monetary easing. Policy makers have said they won’t raise interest rates until joblessness is below 6.5 percent while inflation averages 2.5 percent or less.
Price increases are below that target. The Treasury sold $18 billion of five-year Treasury Inflation Protected Securities on April 18, with investors bidding $2.18 per dollar of debt sold, the lowest demand since October 2008.
The spread between five-year yields on TIPS and Treasuries not indexed for inflation, which shows the market’s expectations for inflation during the life of the debt, fell as low as 1.94 percentage points, the lowest since August, from 2.42 percentage points on March 14.
Inflation was 1.3 percent in January and February, matching the slowest pace since 2009, according to the Fed’s preferred measure, the personal consumption expenditures index deflator, the Bureau of Economic Analysis said March 27. The consumer price index declined 0.2 percent in March, the first drop since November, the Labor Department said April 16.
Three regional Fed presidents said last week the prospects of too little inflation might lead the central bank to increase bond buying.
St. Louis Fed President James Bullard said April 17 that policy makers “should defend the inflation target from the low side,” a sentiment echoed by Minneapolis Fed President Narayana Kocherlakota the following day.
Richmond Fed President Jeffrey Lacker, a critic of current policy, said April 18 that “if inflation looked like it was going to sag further on a persistent basis, I would certainly consider stimulus for the purpose of bringing inflation up to target.” Lacker’s concern about disinflation comes even as he has advocated curtailing easing.
“Everyone got so caught up with the Fed exit from QE that they forgot the Fed can actually ramp it up,” George Goncalves, head of interest-rate strategy in New York at primary dealer Nomura Holdings Inc., said in a telephone interview on April 17. “If conditions change and they get worse, they can do more. It’s a two-way street.”
Nomura is forecasting the Fed will begin to slow purchases in September and end them by March 2014.
Primary dealers’ expected dates for Fed bond-buying to start tapering and finish
Company Tapering Starts Tapering EndsBank of America March 2014 Sept. 2014 Bank of Montreal Q4 2013 Early 2015 Bank of Nova Scotia Q4 2014 Mid 2015 Barclays Q1 2014 Q2 2014 BNP Paribas Dec. 2013 2015 Cantor Fitzgerald Q4 2013 Q4 2014 Citigroup Global Markets Sept./Oct. 2013 Q1 2014 Credit Suisse Sept. 2013 March 2014 Daiwa Capital Markets Q3/Q4 2013 Q4 2013/Q1 2014 Deutsche Bank Q3 2013 Dec. 2013 Goldman Sachs Dec. 2013 Q3 2014 HSBC Securities Q4 2013 N/A Jefferies Q1 2014 Q2 2014 JPMorgan Chase Dec. 2013 Q2 2014 Mizuho Securities Q1 2015 Q2 2015 Morgan Stanley Q1 2014 Mid 2014 Nomura Securities Sept. 2013 March 2014 RBC Capital Markets Q4 2013 Q1 2014 RBS Securities Sept. 2013 Early 2014 Societe Generale Sept. 2013 Dec. 2013 UBS Q4 2013 June 2014