The Fed
The Federal Reserve (Fed) cut its monthly bond buying program again by $10 billion last month in its latest measured attempt to reduce QE. The Fed has tapered its bond buying for a fifth straight month to $35 billion, and is on pace to end the program later this year.
Yield Curve
Last month, the shape of the U.S.Treasury yield curve steepened in the short-end but flattened in the long-end as the “belly” of the curve (2-7yr) increased in yield relative to the other areas of the curve. The yield spread between the 3-month bill and 5-year note climbed by 0.10% to 1.61%.
Expectations of the Fed raising short-term interest rates grew in June on improved employment and slightly higher inflation levels.
Interesting Observation
Inflation is running at approximately 2.0%, now matching the pace of the Fed’s target. While not a pressing concern for the Fed at the moment, the financial market will be keeping a close eye on upcoming data.
Monthly Wrap-up
As time passes and as the economy slowly improves, it will become increasingly more challenging for the Fed to definitively justify their dovish monetary policy stance. On one side, Chair Yellen has repeated that the Fed is likely to reduce QE in further measured steps and that it expects interest rates to stay low for a “considerable time” after tapering ends. On the other side, some Fed officials and investors believe that due to the recovery in U.S. credit markets since the 2008 financial crisis and a strengthening economy, it is becoming more difficult to argue that credit markets remain pressured and that there is a need to keep interest rates unreasonably low.
Another component to the policy stance argument is the recent rise in inflation growth. Now at approximately 2%, inflation is at its highest level since November 2012. In the Fed’s defense, however, the FOMC appears to be more concerned about a failure to receive a sustainable economic recovery than in allowing inflation to move beyond its desired target and is willing to tolerate higher levels of inflation to achieve their dual mandate policy goal. Going forward, the question most on the minds of the investment community will be: What comes next for the Fed after the bond buying is complete later this year?
