Finally, the Federal Reserve had an acceptance tone – yes, it is enough as we have manipulated (read: damage) the bond market significantly, now let the economy decide the price. Thus, the situation is such that in the last two days the price discovery dynamics came into the picture as investors dumped treasuries in heavy number and amount.The yield for 10-yr bonds surpassed 2.55 percent, first time in 22 months.
According to ICAP, the last trading day of the week (ended June 21) witnessed a surge of almost 14 percent in trade (compared with 20-days average) to around $490 billion. Traders started offloading longer-dated treasuries (most vulnerable to these sort of circumstances), but the surprising factor was they also sold 7-yr and 5-yr notes in huge amount, betting the Fed will soon raise short-term interest rate. The market sentiment could be even judged by changes in Eurodollar futures. The three month borrowing rates for December 2014 contract increased on the expectation that short-term rate will rise in the coming quarters.
According to Bloomberg report, the 5- yr TIPS have changed dramatically, so have the Eurodollar futures. Based on technical charts, many analysts expect the 10-yr bond yield to touch 2.75 percent in the coming days. The sell-off in the bond market has spiked mortgage rate. According to Paul Krugman, the nobel prize-winning economist, the Fed has played dangerously with the interest rates in the last five years, and he suggests the Fed should accept inflation target of 3-4 percent. It is very pertinent to mention that Krugman wrote and affirms the importance of the determination of natural rate of interest in the current context of the U.S. economy.
Since the U.S. Fed has already played its cards, now time will tell us how the interest rate regime will turnaround. It would be interesting to see how the wider market spectrum of equity, debt and derivatives are going to behave.