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Bond vigilantes ‘outmanoeuvre’ US Fed
25 November 2013
Ashmore analysts suggest US central bank unable to control investors
Federal Reserve chairman Ben Bernanke's attempts to control
the long end of the curve by stressing that tapering is not the
same as rate hikes has seen him lose ground in the 'battle'
with bond vigilantes, according to Jan Dehn, head of research
and Gustavo Medeiros, portfolio manager at Ashmore.
"The Fed's power to influence the bond market has become
very asymmetric," they explained. "It is (almost) the only game
in town when it comes to buying US Treasuries - in Q2, for
example, the Fed was the only net buyer in the market.
Therefore, rates can easily go up if the Fed stops buying. But
there are limits to how high long rates will go, because higher
yields have effects on the real economy."
Following the market's rough dismissal of Bernanke's verbal
guidance in May, the Fed will try stronger medicine next time
it seeks to taper, suggested Dehn and Medeiros. "Currently the
most talked about innovation is to adopt a lower 6% formal
unemployment threshold for hiking rates. Thus armed, the Fed
hopes to taper again, mostly likely early in 2014, without
blowing up the long end of the Treasury curve."
However, they expressed doubt that a formal lower
unemployment threshold will deter bond vigilantes for three
• A lower unemployment threshold is just another
verbal commitment that can be broken at any time
• Bond vigilantes know that the Fed has very little
concrete ammunition to back its verbal guidance
• There is plenty of liquidity to fund speculation
against the Fed and the cost of shorting the long end of the US
treasury curve is quite low