At a little after 2 p.m. on Wednesday August 12 the Federal Reserve will be either naughty or nice. From Wall Street’s perspective, anyway.
Naughty, according to Wall Street, would be a press release that confirms the Fed’s view that the economy is in a shaky state but that does nothing to change policy.
Nice, and that sound you hear is bond traders salivating, would be a statement that says the Fed is going to increase its buying of Treasury bonds and mortgages. Both buying sprees–$300 billion for Treasuries and $1.25 trillion in morgages–are drawing to a close and Wall Street would love to hear that the Fed is going to up its buying limits.
That would drive down interest rates–which have been rising lately–and send bond prices–which have been falling lately–climbing.
Without that kind of news from the Fed, bond traders fear that 10-year Treasury notes will fall in price and test a yield of 4%.
Do I need to remind you that rising interest bond yields aren’t good for the stock market since they make bonds more atractive vis-a-vis stocks?.
Wall Street is especially nervous going into Fed day because it’s looking at a truck load of Treasury sales in the next couple of days beginning with the auction of $25 billion in Treasury notes about an hour before the Fed announcement. If Wall Street is uncertain enough about what the Fed will say, buyers might be scarce at that auction. That in itself would be enough to send Treasury yields up another notch closer to 4%.
That wouldn’t bode well for the auction of another $15 billion in 30-year Treasury bonds scheduled for Thursday.
The Federal Reserve has been buying Treasuries to add liquidity to the financial markets and mortgages to lower mortgage interest rates. The original targets for those buys would see the Fed finish its purchases of Treasuries within six weeks and of mortgages by the end of the year.
On the other hand, a decision by the Federal Reserve to extend those purchases would feed the fear of investors, especially overseas investors, that the Fed will not be able to extricate itself from the financial markets before it sets off a round of higher inflation.