Photographer: Andrew Harrer/Bloomberg

Fed Struck by Boomerang Effect as Rate Move Boosts Long Bonds

  • Higher interest rates boost dollar, denting commodities prices
  • Lower raw materials costs dim inflation, boosting fixed income

The Federal Reserve has ignited a chain reaction in markets and government bonds are the beneficiaries.

To understand how means following the links between financial assets -- from foreign exchange to commodities to fixed-income.

With its decision on Wednesday to raise interest rates for the first time in nine years, the Fed fueled appetite for U.S. assets that’s drawing in demand for the dollar from overseas.

Dollar Jumps...

That’s a downer for prices of metals, oil and other raw materials. They tend to fare poorly when the greenback strengthens because they’re traded in dollars, so costs for countries with weakening currencies escalate, hurting demand. Their lack of yield also dents their allure when rates rise because they only deliver returns though price gains.

The Bloomberg Commodity Index fell for a sixth straight day on Thursday, dropping to the lowest since 1999.

“A stronger dollar will make commodities more expensive in other currencies, potentially limiting demand,” said David Wilson, an analyst at Citigroup Inc. in London. “A lot of macro-investors will look at it this way, with a resulting influence on price.”

...Pushing Down Commodities....

Conversely, bonds benefit from cheaper raw-material prices because they curb inflation and preserve the value of the fixed payments on debt. Longer-term securities are more sensitive to the inflation outlook than monetary policy, helping them to outperform.

...And Boosting Longer-Maturity Bonds

Treasury 30-year bond yields dropped five basis points on Thursday to 2.95 percent, more than undoing their losses in the immediate aftermath of the Fed’s move. Germany’s 30-year yield tumbled eight basis points to 1.37 percent.

“We got what we expected from the Fed and now the oil price continues to slide down,” said Jens Peter Soerensen, chief analyst at Danske Bank A/S in Copenhagen. “Short term this pushes down people’s inflation expectations and that’s fairly positive for European bond markets. We are pretty confident on bonds in general.”

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