The US enters the third wave of the pandemic with 140,000 daily cases.
Investors are weighing the possibilities of the Federal Reserve increasing its purchases of US government debt in the coming weeks to counter the economic fallout from the resurgence of COVID-19, an intervention that could reverse the recent surge in Treasury yields, which they have risen to their highest levels in several months.
News in recent days that two coronavirus vaccines proved highly effective in late-stage testing has fueled investors’ risk appetite, causing yields, which move inversely to bond prices. , reach their highest levels since March and that the stock markets of the United States register all-time highs.
However, some investors believe that the increase in coronavirus cases may threaten the fragile economic recovery of the United States, at a time when the new fiscal stimulus package is likely to be delayed, with months to go before widespread access arrives. to a vaccine. The United States recorded more than 1 million new cases of COVID-19 last week.
That combination of negative factors could push the central bank to increase its support, according to some investors, despite the fact that asset purchases are already at record levels and the Federal Reserve has not indicated that it intends to increase them at its next meeting. of two days on monetary policy, to be held on December 15 and 16. Federal Reserve Chairman Jerome Powell will speak Tuesday afternoon, and investors will listen closely for the Fed’s opinion.
Steve Englander, head of G10 currency analysis and North America macroeconomic strategy for Standard Chartered (LON: STAN), believes the Federal Reserve may surprise markets by increasing its asset purchases to $ 120 billion a month before the December meeting if it appears that the increase in COVID-19 cases is weighing on the economy.
The Federal Reserve has bought at least $ 80 billion a month since the start of the pandemic.
The Federal Reserve “may feel it needs to act, although it is waiting for the vaccine to come,” Englander says. “It seems like there will be a period of two to three months before the vaccine becomes widely available that looks like it will be very, very painful.”
An increase in bond purchases would likely drag the benchmark 10-year Treasury yield to the bottom of its range between 0.5% and 1%.
The Federal Reserve could also be forced to modify its purchases of Treasuries if positive news from the vaccine pushes the 10-year yield above 1%, according to Priya Misra, global head of rates strategy at TD Securities. Misra believes that the Fed will continue to buy the same amount of debt from the US Treasury, but believes that the share of longer-term bonds will increase.
Rising yields are a potential problem for the Federal Reserve because it raises the cost of borrowing for businesses and individuals, something that could threaten economic growth.
“I think if you get past 1% in (10-year yields) quickly, we might see the Federal Reserve doing it before the December meeting,” says Misra.
The 10-year yield was 0.911% on Monday, after Moderna Inc announced promising results from its vaccine trials earlier in the day. The benchmark yield peaked at 0.975% last week after Pfizer Inc (NYSE: PFE). will announce similar results for its vaccine.
Analysts at JPMorgan (NYSE: JPM) said in a note on Monday that they expect the Federal Reserve to raise the average maturity of its Treasury holdings at its December meeting, which could drive yields down.
Federal Reserve Vice Chairman Richard Clarida, in a speech Monday, gave no direct indication that the central bank was willing to increase its purchases. Some investors are taking the Federal Reserve’s words at face value.
“The markets are doing well and unless we see the need for more lockdowns, I think they won’t make big changes before the end of the year,” said Kevin Giddis, head of fixed income at Raymond James.
However, even if the near-term outlook looks favorable, some investors believe the Federal Reserve will increase its asset purchases as a precautionary measure.
“My view is that the Federal Reserve will increase (bond purchases) to $ 160 billion a month in December, even if we have good news on the vaccine front and regardless of what the news is regarding the economic recovery,” he says Thomas Costerg, an economist at Pictet Wealth Management in Geneva. “They have learned the lessons from previous experiences.”