Fed stimulus to ease bond fears still yet to be justified
By Jimmy Zhu
The Marriner S. Eccles Federal Reserve building in Washington, D.C., U.S., February 19, 2021. /CFP

The Marriner S. Eccles Federal Reserve building in Washington, D.C., U.S., February 19, 2021. /CFP

Editor's Note: Jimmy Zhu is chief strategist at Fullerton Research. The article reflects the author's opinion and not necessarily the views of CGTN.

The Federal Open Market Committee (FOMC) March meeting will be center stage this week, as investors are keen to learn whether the Fed is concerned by the recent rising bond yield.

The 10-year government bond yield has become a major problem for many global assets, including equities, currencies and commodities, in the past weeks. Market participants will focus on the Fed's economic outlook and pay great attention to how Fed officials address the surging borrowing cost and whether they would have tools to cap the bond yield.

The U.S. central bank is in a dilemma. On the one hand, it may be keen to announce that the economic recovery is on the right track after the massive stimulus. However, if they don't do that, it shows that Fed's unprecedented monetary easing since March 2020 didn't work efficiently.

The recent bond market also complicated the situation. If the Fed does not stress the challenges on the path of the recovery, bonds yield would further climb higher from the current level, which would definitely slow the pace of economic recovery.

If the Fed's forecasts become less reliable, investors should focus on its quarterly projections and key economic data. The Fed also upgraded its 2021 real GDP forecast to 4.2 percent from 4 percent in its December meeting and estimated a drop in the unemployment rate to 5.0 percent this year, down from 5.5 percent. On the inflation side, it saw personal consumption expenditures increase to 1.8 percent in 2021.

Based on the recent economic data and Biden's $1.9 trillion stimulus package, the Fed is likely to further upgrade these key economic projections in the meeting this week. If they do so and the projections are beyond the market's general expectations, the 10-year government bond yield may continue to rise.

Over the past decades, the Fed's influence on the long-end bonds yield has been rather limited. The economic condition and outlook had a more significant impact on those bonds. If bond prices are to track the Fed's projection, investors need to prepare for another round of negative sentiment in the financial market triggered by the potential rising yield.

Fed chair Jerome Powell has tried to ease investors' fear as the U.S. government bond yield keeps edging higher in the past weeks. Many Fed officials said the central bank would keep its policy accommodative until the economic condition shows substantial improvement. But the Fed's difficulty now is that it has yet to find an effective communication tool.

Some investors require the Fed to implement more new tools to curb the rising yield, especially when the European Central Bank committed to increasing bond buying last week. However, we don't anticipate that the Fed will hint at using such tools at the current stage. The recent volatility in the stock market is not a valid reason for the Fed to step in. After all, investors need to be clear that the Fed's main objective is to achieve its labor market and inflation goals, not defending the stock market. Furthermore, although the current 10-year government bond yield of about 1.6 percent is well below its potential GDP growth for 2021, the Fed views it as "reasonable."

Some market participants have become concerned about whether the Fed would ultimately lose its control or influence in the bond market if the economic data continues to improve. Given that new infections have decreased in the U.S. in recent weeks, consumer confidence and business activity are likely to continue to recover. Under such a scenario, it's hard to imagine that the Fed will choose to please the "day traders" by committing to implementing more new policy tools.

That said, the probability of a disappointing outcome after the FOMC meeting may be higher. Powell is likely to stick to the view that the tightening stage is still remote and that the Fed wants to see a substantial recovery first. However, the market will be unsatisfied with such a message; the volatility may rise again if Powell doesn't address the matter adequately at the press conference.

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