The action in the two year note today where the yield is up a dramatic 30 bps to 1.25%, the highest since mid Nov, is happening coincident with a move higher in yield in the fed funds futures contracts where the market has somewhat reset their expectations of what the Fed will do. The fed funds futures are pricing in a 48% chance of a 25 bps rate hike by the Sept meeting and that is up from a 2% chance priced in just yesterday. After today’s better than expected payroll figure being the main catalyst for today’s action in conjunction with the ever growing inflation concerns, the Fed needs to decipher what is a readjustment of growth expectations and/or what is related to inflation concerns and whether they will fight these trends in order to keep interest rates low. Reading comments from Fed Pres and voting member of the FOMC Yellen within the past 15 minutes does not give much confidence that they know what’s going on and it seems that they had very little of a game plan going into their QE policy. Using quotes from DJ, she said that while buying MBS and US treasuries got off to a good start with yields heading lower, “there’s a lot that central bankers don’t know about the magnitude and duration of the effects of these policies” and “our standard monetary policy models do not incorporate financial frictions that lead to asset purchases having real effects.” She went on to say “we lack both the data and theory to provide strong guidance on these policies” and “we are sailing in uncharted waters, marking our maps with every bit of information along the way.” Yellen is a career economist and ex school professor so she’s learning first hand what its like to mess with the market. I’m worried if other Fed members are this uncertain.
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