Between vaccines, Brexit, covid surges, covid lockdowns, holiday retail, and various political headlines, it seems like the market should have a diverse range of considerations in the 2nd half of the month. But the fact is that Wednesday’s Fed announcement is the only big market mover remaining in 2020 for the average bond trader. The Fed is not going to change rates or the amount of bonds it buys, but there’s at least some chance it will tweak the proportion of long-term vs short-term bonds. Whether it does or doesn’t, bonds are planning to react.
Reactions to Fed announcements are never guaranteed, but the more evenly split the consensus, the higher the likelihood of a move. While it seems the consensus is tilted slightly in favor of the Fed sitting on their hands, the past 2 weeks of bond trading suggest it’s a close call. 10yr yields avoided breaking the prevailing ceiling last week before proceeding to trade in a narrow, sideways pattern.
If traders were certain the Fed would be adjusting its bond buying ratios, odds are that yields would be pushing more convincingly into the 0.8% range. And if we could be sure the Fed would do nothing on Wednesday, it’s hard to imagine yields under 1.0%.
So what exactly are we looking for from the Fed? It’s all about WAM, or the “weighted-average maturity” of its bond portfolio. WAM is one of those concepts that sounds complex at first glance, but it actually quite simple. Think of a 6-year auto loan vs a 3-year, or a 30yr mortgage vs a 15yr. Longer loan terms = longer “maturities” for the underlying bonds. The more longer-term debt the Fed is buying, the better it would be for longer-term rates.
A practical example, taken to the extreme: if the Fed were to completely stop buying every Treasury with a maturity under 9 years and only buy those with maturities of 10 years or more, they could instantly cause a rather large increase in 2yr Treasury yields and a substantial decrease in 10 year yields without changing the dollar amount of the monthly bond buying program. Granted, the shift in question would not be so “all-or-nothing,” but even a small change would be enough to get the market’s attention.
After Wednesday afternoon’s Fed announcement, there’s not much left between 2020 and the new year. At that point, econ data, new year trade flows, covid case counts, and vaccine distribution updates will set the tone. By mid month, Georgia’s senate elections provide the biggest potential source of momentum. While there’s no particular reason to expect one outcome over another at this point, a democratic sweep is the outcome that would likely push rates significantly higher.