EC Inside And Outside, Market And Models Actually Agree On A Final Failing Grade For Yellen

It was another pretty embarrassing day for the Federal Reserve and its policymaking body the FOMC. The latter voted, as expected, to raise the federal funds corridor (or double floor, if you can’t get over IOER fail) by another 25 bps. The long end of the Treasury bond market, however, was bid pushing yields down not up. There is a reason the 10-year UST is considered the main benchmark, meaning that these are not really “rate hikes” but RHINO’s (rate hikes in name only).

It was a perfect demonstration of curve dynamics, in this case meaning Fed officials really don’t know what they are doing. If it was otherwise, long bonds would be trading as the FOMC would like – rising nominal yields all along the curve short and long respecting monetary policy where curve flattening happens way higher than here.

Instead, US central bankers have convinced themselves at least in the majority that the bond market is only temporarily resisting their outwardly more positive views until it gets its parts in order. And by parts, I mean yield deconstruction and those stupid term premiums again.

The Fed is raising rates because it believes inflation is going to accelerate if more gently in its ascent. That for them takes care of the bottom two parts of the long end breakdown – the market has to be expecting higher short-term rates (because of the “hikes”) in addition to higher inflation expectations (the reason for the “hikes”). Once “term premiums” head back toward normal as Ben Bernanke, among others, has been expecting for years now, that’s when the official view will be proven correct.

It’s just a matter of time, right?

I suppose that makes term premiums transitory like everything else that doesn’t validate the inflexible official position. To start with, the mere fact that the Fed is raising the reference corridor for money alternatives (these RHINO’s) does not immediately propose the market is expecting higher short-term interest rates (the bottom part of the yield curve decomposition).