The Treasury Yield Curve And FOMC Meeting In Focus

The Federal Open Market Committee is set to meet in early May to decide whether it will continue to raise rates. Now, traders are pricing in this event already, and they’re expecting rates to remain unchanged, just a few weeks ahead of the meeting. The yield curve has been flattening, which has benefitted Treasury securities, and in turn has boosted some Treasury bond exchange-traded funds (ETFs).

Treasury Yield Curve

The yield curve is quite simply a plot of interest rates at specified maturities at some point in time. If you compare the Treasury yield curve from the beginning of the year and late April 2017, you’ll notice the yields for longer maturity Treasury securities have fell. However, after Yellen raised rates recently, you’ll notice yields have rose for shorter term Treasury securities. Here’s a look at the comparison between yield curves:

Source: U.S. Department of Treasury

Trader Jason Bond stated, “The flattening of the yield curve has boosted bond prices, due to the inverse relationship between interest rates and bonds. We’ve seen the iShares Barclays 20+ Year Treasury Bond ETF (NASDAQ: TLT) move from $119.13, as of the close on December 30, 2016, to $123.54 on April 21, 2017, over a 3% gain over that period, but there was some volatility in the name due to some uncertainty in the previous FOMC meetings.”

Now, the yield curve and outlook of the U.S. economy also affects gold prices. With the recent fall in rates, investors and traders may be anticipating that inflation over the longer term might not be as high as the markets have expected following Trump’s win. That in mind, we’ve seen gold prices rally from around $1,150 per ounce in January 2017 to above $1,290, at one point in April 2017. Generally, investors will flock to gold, as it is seen as a safe haven, when the outlook on the economy is pessimistic.

What The Markets Are Expecting

Traders may have already dismissed the Fed’s recent comments indicating the economy has been strengthening. Now, if you look at the long end of the Treasury yield curve, in the chart that we introduced earlier, the market may not be as optimistic in the economy as it was a few months ago. That in mind, longer-dated Treasury securities currently have yields lower than what market participants would want to see when the economy is strengthening.

According to IMF Director Tobias Adrian, “he Federal Reserve has an additional policy tool which is the size of the balance sheet and it can use that policy tool to impact longer term yields. We feel that it should use that tool in a predictable manner so that it doesn't generate surprises in the market place.”

With that said, the FedWatch Tool was indicating that there was over a 90% probability that the Fed would leave rates unchanged, as of April 21, 2017. Here’s a look at the Fed Watch Tool probabilities:

Source: CME Group 

Another  stated, “With the market expecting the Fed to leave rates unchanged, the FOMC is not expected to surprise the markets in its May meeting.”

What Now?

The markets are expecting the Fed to leave rates unchanged, and the outlook of the economy may be shifting from optimistic to slightly pessimistic. That in mind, it’ll still be interesting to see what the Fed says in its next meeting.