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Bets on More Fed Bond-Buying Help Contain Treasury Yields

12/02/2020 | 05:45am EST

By Sam Goldfarb

Some investors are betting that the Federal Reserve could start buying more long-term U.S. Treasurys as soon as its next policy meeting, a trend that has helped temper some recent selling and kept yields from rising higher.

One factor influencing such bets: the outcome of the Nov. 3 election, which resulted in the strong possibility of divided government in Washington and left investors thinking the Fed might need to assume more responsibility to support an economy increasingly buffeted by a surge in coronavirus cases.

Treasury Secretary Steven Mnuchin's decision to not extend several emergency Fed lending programs beyond Dec. 31 also left the Fed with fewer alternatives to Treasury purchases for economic stimulus. Buying bonds helps boost the economy by reducing longer-term Treasury yields, lowering the cost of borrowing for individuals and businesses.

Minutes from the Fed's Nov. 4-5 meeting released last week offered few clues about prospects for policy changes at the central bank's next meeting on Dec. 15-16. Officials in early November didn't think it was necessary to make immediate adjustments to their bond-buying program. But they "recognized that circumstances could shift to warrant such adjustments," the minutes said.

Renewed hopes that Congress could pass some sort of coronavirus-aid package in a lame-duck session helped lift the yield on the benchmark 10-year U.S. Treasury note to 0.933% on Tuesday from 0.845% Monday. But that remained below the 0.970% mark it reached three weeks ago, just after Pfizer Inc. released highly encouraging results from its coronavirus vaccine trial.

Several investors and analysts said the prospect of more long-term bond purchases has already accomplished a measure of what Fed action might: bolstering demand for bonds and putting downward pressure on yields, which fall when bond prices rise.

John Briggs, head of strategy for the Americas at NatWest Markets, said he doesn't think the Fed will change its bond-buying program this month. Still, he said he had thought for weeks that "market speculation about [a possible change] would increase, which would help keep yields a little bit contained." If anything, he said, that happened sooner than he had anticipated.

It has been a bumpy ride for yields recently.

In the month before the Nov. 3 election, the yield on the benchmark 10-year U.S. Treasury note climbed to around 0.9% from just under 0.7%, based largely on expectations that Democrats would win the White House and both chambers of Congress. That would allow them to pass trillions of dollars in new spending measures that would both stimulate the economy and increase the supply of government bonds.

When Democrats didn't win as many Senate seats as expected, the 10-year yield quickly fell back under 0.8%, according to Tradeweb. The following week, it rebounded after Pfizer's announcement, only to be again pulled down by investors' concerns about rising coronavirus cases and the possible Fed response.

The Fed right now is buying around $80 billion of Treasurys each month along with $40 billion of mortgage-backed securities, net of redemptions. In September, officials clarified that the purchases were intended to support the economic recovery, after being initiated in March to improve the technical functioning of the bond market.

Most investors don't expect the central bank to increase the total amount of Treasurys it buys on a monthly basis. But some think it could shift its purchases toward more longer-dated Treasurys. That could provide more economic stimulus because short-term Treasury yields are already close to zero and many individuals and business take out longer-term loans.

Analysts said there are several reasons why the Fed might not adjust its bond purchases this month.

For one, the goal of buying more long-term Treasurys would be to ease financial conditions. But financial conditions are already quite loose, with stock indexes around record highs and Treasury yields still below their pre-2020 lows.

In addition, many investors anticipate that Congress will pass a coronavirus-relief package in the coming months, even if they expect less than they did before the election.

The Fed, therefore, might be able to wait until after Dec. 16 to see if it needs to ratchet up its stimulus. And it could always make policy adjustments between meetings, analysts said.

Thomas Simons, money-market economist in the fixed-income group at Jefferies LLC, said Jefferies had previously expected the Fed to shift its bond purchases to more longer-dated Treasurys, but that it had abandoned that call after the central bank didn't act in previous meetings.

If officials were seriously considering an adjustment, they would be doing more to signal "what would be a pretty major change in their policy," he said.

Whatever happens over the next few weeks, many investors expect Treasury yields to rise next year as coronavirus vaccines are distributed and the economy returns to more normal footing. Even if the Fed has altered its bond-buying program in the interim, faster growth could lead to higher yields by spurring a higher rate of inflation and hastening the day when the Fed can dial back its stimulus.

Many investors, however, aren't willing to go all into that bet just yet.

Jim Caron, head of global macro strategies for Morgan Stanley Investment Management's fixed-income team, said the 10-year Treasury yield could reach around 1.25% by the spring or summer of next year because of the combination of coronavirus vaccines and more economic aid from Congress.

Still, he isn't reducing longer-term Treasurys in his portfolios just yet, partly because of the protection they offer if the economy performs worse than expected this winter.

Write to Sam Goldfarb at sam.goldfarb@wsj.com

(END) Dow Jones Newswires

12-02-20 0544ET

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