The Fed and Fixed Income Markets
What might the Fed's new framework and tapering plans mean for investors? Loomis, Sayles & Co. Full Discretion Co-Head and a Senior Sovereign Analyst discuss implications.
Highlights from their conversation include:
- Quantitative easing is effective at reducing real yields. Tapering quantitative easing has the opposite effect, tending to drive real yields higher.
- A tapering Fed will probably usher in more market volatility in the months ahead.
- The risk of tightening prematurely appears to be less palatable to the Fed from both an economic and political perspective.
- The Fed is trying out a whole new framework amidst an unprecedented pandemic shock. So there’s going to be a real onus on the Fed to tell the market what’s happening in terms of inflation, how and when it’s going to take a response, and how that response is consistent with its new framework.
- With inflation and yield curve risks so elevated, active management in fixed income becomes increasingly important.
- Bidenomics is raising the profile of the government’s involvement in the economy.
All investing involves risk, including the risk of loss. Investment risk exists with equity, fixed income, and alternative investments.
Fixed income securities may carry one or more of the following risks: credit, interest rate (as interest rates rise bond prices usually fall), inflation and liquidity.
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Yield curve shows the relationship among bond yields across the maturity spectrum. Yield curve risk refers to the probability that the yield curve will shift in a manner that affects the values of fixed income securities – particularly, bonds.
Real yield is the nominal yield of a bond minus the rate of inflation.
Unlike passive investments, there are no indexes that an active investment attempts to track or replicate. Thus, the ability of an active investment to achieve its objectives will depend on the effectiveness of the investment manager.
Quantitative easing refers to monetary policy in which a central bank purchases government securities or other securities from the market in order to lower interest rates and increase the money supply.