“It started subtly, about a month ago, in the fed funds futures market, where investors had come to view Federal Reserve Chairman Ben Bernanke’s word as deed: first, the August pledge to hold the benchmark rate near zero until mid-2013; then, on Jan. 25, the extension of that target date to late 2014.
Investors priced fed funds futures contracts accordingly. At least they did until early February, when traders started to challenge the Fed’s forecast ever so slightly. (The contracts are cash-settled against the effective federal funds rate for the particular delivery month.)
The March 2014 contract, for example, peaked at a high of 99.77 on Jan. 30, an implied yield of 0.23 percent, within the Fed’s current 0 to 0.25 percent target. The yield rose to 0.65 percent earlier this week. Volume and open interest shot up, as well. Even the late-2013 contracts are starting to suggest zero isn’t a sustainable equilibrium.
Last week, the unthinkable happened: Long-term notes and bonds took a shellacking even as the Fed gobbles up the equivalent of the Treasury’s long-term issuance.
Not content merely to project a path for overnight rates, the Fed has engaged in several rounds of bond buying since 2009 — more than $2 trillion of Treasuries and agency mortgage- backed securities — to ensure that long rates don’t start thinking independently. A manipulated market leaves little room for self-expression, even among those gun-slinging Masters of the Universe….”
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