The Federal Reserve’s (Fed) rapid response to the COVID-19 crisis last year included several extraordinary monetary policy actions, including a fourth round of large-scale asset purchases or quantitative easing (QE). This week’s chart highlights the dramatic impact recent Fed purchase activity continues to make on valuations for Treasury Inflation-Protected Securities (TIPS). 10-Year TIPS yields (or real yields) declined deeply into negative territory after the Fed renewed the QE program and remain near the lowest levels seen since TIPS were first issued nearly 25 years ago.
The Fed’s ownership of TIPS increased substantially following its most recent round of QE and now represents more than 25% of the total TIPS market. Numerous factors have contributed to the sharp fall in both nominal and real yields during the past 18 months, but QE ranks near the top. The long-standing mantra of “don’t fight the Fed” has given bond investors a green light to take risk, keeping interest rates and credit spreads near historic-low levels.
The Fed is likely to begin its long-anticipated tapering process following next month’s Federal Open Market Committee (FOMC) meeting. Even though tapering does not mean the Fed will be selling assets or reducing the size of its nearly $8.5 trillion balance sheet. Valuations for TIPS, which have historically traded with less liquidity than nominal Treasury bonds, are vulnerable should the Fed move at a faster pace toward normalization of monetary policy than bond markets are pricing in today.
The material provided here is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.
This material is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management. This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.
Opinions and statements of financial market trends that are based on current market conditions constitute judgment of the author and are subject to change without notice. The information and opinions contained in this material are derived from sources deemed to be reliable but should not be assumed to be accurate or complete. Statements that reflect projections or expectations of future financial or economic performance of the markets may be considered forward-looking statements. Actual results may differ significantly. Any forecasts contained in this material are based on various estimates and assumptions, and there can be no assurance that such estimates or assumptions will prove accurate.
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High-Yield bonds are subject to greater fluctuations in value and risk of loss of income and principal. Investing in higher yielding, lower rated corporate bonds have a greater risk of price fluctuations and loss of principal and income than U.S. Treasury bonds and bills. Government securities offer a higher degree of safety and are guaranteed as to the timely payment of principal and interest if held to maturity.
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