"Hopium" still there, but why when the FOMC are clear about what they expect.
The FOMC announced that they are extending Operation Twist until the end of the year, beyond the expiry of next month. The FOMC therefore, to me, is ruling out any new form of Quantitative Easing,QE3, this year. The Equity markets are focusing on the last statement of the FOMC statement , "The Committee is prepared to take further action as appropriate to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability. " But this is nothing new and is a normal statement from the Fed, I struggle to understand why the equity market sees this now as a sign of imminent QE3.
The Fed announced their new economic forecasts and they weren't pretty. 2012's GDP forecast was cut by 0.5% from April's projection and 2013 was also cut similarly , and still seems optimistic to me at 1.9%-2.4%. The Unemployment rate was forecast to be higher for the next 3 years, but still seems optimistic. Inflation predictions fell and are now below the 2% long term target of the Fed.
So why the sell-off in 10yr US Treasuries? I do wonder, the 10yr US Treasury yield is now 1.65%. But commodity prices fell today!. It is just the "hopium" from the Us Equity markets trying to suck retail investors in and misleading political reporting from Europe. The decline in commodities should drive inflation expectations lower across the US Inflation curve.
The French, Spanish and mostly Italian press are desperate to push the creditor Northern nations of the Euro zone into bailing them out. It has always been known that the ESM will be able to buy sovereign debt, but this will have to be voted on by all the member countries of the ESM. Of the 13 countries, at the moment it is probably split 7-6 in favour of not buying Italian and Spanish bonds. And it would seem unwise for the French, Spanish and Italians to force a vote when the German's are so obviously going to oppose it. Even if the Italians persuaded other countries and they achieved a majority against the wish of the Dutch or Finns for instance it would create a schism in the Euro zone that would ultimately lead to the collapse.
And so to Risk markets- Interest Rate Implied Volatility has declined throughout the day. We have seen small declines in historical volatility over the past 2 days, but nothing to justify the decline we have seen in the Implied Volatilities. As such I would be sure that the volatility levels will rise again, and given the sharp flattening of the yield curve seen today, that seems even more likely.
So, over the coming days I would expect the "hopium" to fade and the bond markets to become more focused on the weaker economic outlook.
Tomorrow, after European PMI's, the Phili Fed report is released, given the Fed's gloomy economic outlook I would expect the survey to show significant weakness and also growing deflation expectations. That should be a trigger for a significant rally in US Treasury Bonds. With the Fed out of the game for the rest of the year the markets will have to fend on their own for the next 6 months. It won't be a pretty time for Risk markets.
I am looking for 10yr US Treasury yields to comfortably fall below 1.50% in coming days.