Monday and Tuesday brought a stronger start for bonds and, with it, hopes that a broader bounce was in the works. Wednesday dashed those hopes and intensified focus on today’s livestream Q&A with Fed Chair Powell. Other central banks have more than acknowledged the recent rise in longer-term rates by going so far as to offer reassurance that they’d step in as needed to keep additional spikes in check. But the Fed has been almost completely silent on the topic.
In fact, when Fed speakers have mentioned higher rates, it has typically been to say that they make good sense and that they stand as evidence of progress in achieving their goals. Recall that in the last few months of 2020, we were actively discussing the prospects for WAM extensions. WAM = weighted average maturity, which is hifalutin way to refer to how many years an investor’s average bond holding will last.
Bonds are loans and/or debt. If a buyer/investor has high WAM, they are relieving a debt burden from whoever is borrowing for a longer amount of time, thus allowing the borrower to borrow more in the short term. That’s important in this case because demand doesn’t fluctuate nearly as much on shorter-term debt. If the Fed has pledged to keep it’s policy rate at zero for at least a few years, investors can confidently use short-term debt as a risk-free, highly liquid place to park cash and earn a smidgeon of returns.
For whatever reason, some combination of journalists, analysts, and perhaps even a trader or two have decided that a WAM extension is suddenly a thing the Fed will have to announce shortly. They don’t usually say “WAM” though. They say “twist”–a reference to “Operation Twist” which is how the Fed has referred to previous campaigns to sell shorter-term debt and buy longer term debt.
My first inclination is to say that no one who is suggesting an impending twist operation has heard anything the Fed has been saying recently, and that there’s no chance Powell even alludes to the possibility. If anything, he’s more likely to say “no, we’re not considering that at this time, and it would be counterproductive to our goals.” But surprises happen all the time when it comes to markets and Fed speakers, so I will acknowledge “anything’s possible,” and temper that acknowledgement by saying the very best we could possibly get from Powell on that note would be something to the effect of “we could reconsider extending WAM if market conditions continue to deteriorate in a way that affects our progress toward our dual mandate of full employment and price stability.”
If (and it’s a huge IF) that happens, it would mark a complete 180º from most of the Federal Reserve members who’ve spoken publicly in the past few months. Virtually all of them have said they’re not considering WAM/twist at this time, and that it’s not the right policy tool for their objectives–especially in light of inbound fiscal stimulus (but that it remains in the arsenal for future use).
Long story short, some of the voices in the market seem to have greatly overestimated the Fed’s willingness to “twist.” To whatever extent those voices represent current trading positions, bonds could have a rough afternoon. My sincere hope is that most of those voices are journalistic and analytical as opposed to “institutional” (as in “institutional investors” who drive much of the day-to-day bond market momentum). If that’s the case, the market would be more free to interpret what’s almost certain to be a less heavy-handed message from Powell. Either way, be ready to react in the PM hours. Powell’s live stream allegedly begins at 12:05pm ET.