The market is looking for clues from the Fed on whether it will adjust bond buying

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U.S. Treasury Secretary Steven Mnuchin and Federal Reserve Chair Jerome Powell are seated to testify before a House Financial Services Committee hearing on oversight of the Treasury Department’s and Federal Reserve’s coronavirus disease (COVID-19) pandemic response on Capitol Hill in Washington, U.S., September 22, 2020.
Joshua Roberts | Reuters

The Federal Reserve could provide clues about its bond buying program when it releases its minutes Wednesday, but the odds the central bank takes action at its December meeting have fallen slightly with the expected nomination of Janet Yellen as Treasury Secretary.

Minutes from the Fed’s last meeting are released Wednesday at 2 p.m. ET. The Fed talked about possible ways to adjust the program at that early November meeting, so it may reveal some aspects of that discussion.

Market speculation had been building that the Fed will tweak the bond buying program when it meets in December by changing the duration of the bonds it is buying but keeping the total Treasury purchases at $80 billion a month. The theory is if the Fed increases the purchases of longer duration Treasurys, like 10-year notes and 30-year bonds, that would keep the rates that impact mortgages and other loans from rising.

Vincent Reinhart, chief economist at Mellon, said the minutes may not reveal much other than that changing the average duration of its purchases is just one possibility. “The minutes aren’t about news. On one level, there’s going to be a natural disappointment,” he said. “We probably will get information on their intentions on asset purchases and whether it’s going to be more rules based.”

Yellen is expected to be named to the Treasury by President-elect Joe Biden, and as a former Fed chief is expected to be sympathetic to the Fed and also an advocate for fiscal stimulus. Some market pros had expected the Fed to move in December on its bond program because Congress has failed to approve more stimulus for the economy as the virus outbreak is worsening. Some theorize now that the Fed could hold off on the bond program, if it knows Yellen is a strong advocate for other stimulus.

“I still think it’s a possibility. It’s a coin toss. It might have been 60/40, but with [Yellen] possibly being the Treasury Secretary, maybe there’s a ‘let’s see,'” said Jim Caron, head of global macro strategies at Morgan Stanley Investment Management.

The 10-year Treasury yield, edging towards 1% earlier this month, has been trading lower based on speculation the Fed would buy more Treasurys in that sector. The 10-year yield was slightly higher Tuesday at 0.88%.

The market has been split on whether the Fed would move, but expectations increased after Treasury Secretary Steven Mnuchin last week informed the Fed that the Treasury would not extend some of the Fed’s emergency programs that expire at the end of the year.

But strategists say Yellen would likely move to restore those programs fairly quickly if the Fed believes it still needs those backstops. Among the facilities impacted were the Fed’s programs for corporate debt and municipal debt.

“The best metaphor is Secretary Mnuchin took down the guardrails they put up, and year end is a sharp turn and that is dangerous,” said Reinhart. But he added the Fed still has control of the programs it needs to manage the markets across year end, like the repo operation.

He said if the Fed moves on the bond program, it actually may not have much impact. “You’ve got the 10-year Treasury as low as you want. They’ve got housing fully on the boil,” he said.

After the November meeting, Fed Chairman Jerome Powell said that the Fed had a “useful discussion” about the bond buying program, but he felt it was effective and the Fed was providing the right amount of accomodation.

The Fed is buying a total $120 billion a month in its asset purchase program, including $40 billion in mortgage securities. If the Fed were to change its Treasury purchases, market pros say it could double the nearly $10 billion it is buying at the long end of the curve.

Ian Lyngen, head of rate strategy at BMO, said Yellen’s nomination may not make much of a difference. “On the margin, I would say it might make the decision to follow through with an extension of the weighted average maturity of Treasury purchases slightly more difficult. However, I don’t think it changes the calculus at the end of the day. At this point I think the market thinks they do it,” said Lyngen. He said the 10-year yield could move back towards 1% if the Fed does not increase the longer end purchases.

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