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Interest Rates on the Rise

June 19th, 2013 3:08 PM by Gregg Mower

(Reuters) - Stocks tumbled and benchmark Treasury bond yields rose to levels not seen since March 2012 on Wednesday after Ben Bernanke laid out a blueprint for the wind-down of the Federal Reserve's bond-buying program that has bolstered risky assets.

Bernanke's comments were more explicit than markets expected. He said the Fed's policy-setting committee will begin to pull back on purchases later this year if the economy grows as expected, with the eventual goal of ending the program by the middle of 2014.

Bernanke was careful to say that should economic conditions change, the Fed could hold off on a pullback in its purchases of $85 billion in bonds per month. However, the tone of his remarks, along with more optimistic official forecasts from the Fed, sent investors to the exits.

"These hawkish statements really sent both the equity market and the bond market into a tailspin," said Paul Montaquila, a fixed income investment officer with Bank of the West and BNP Paribas Securities Corporation.

"I don't think the markets expected such a positive spin on the economy."

Bond prices were hardest-hit, with both 10-year and 30-year Treasury bonds falling more than 1 point in price. The 10-year's yield rose to 2.33 percent, the highest since March 2012. Equity markets lost more than 1 percent following the comments, while the dollar rallied, as higher interest rates increase the appeal of U.S. assets to foreign investors.

The dollar jumped sharply against the euro and yen. The U.S. currency was up 1.2 percent at 96.44 yen. The euro last traded at $1.3280, down 0.8 percent. Gold was lower.

The MSCI world equity index .MIWD00000PUS lost 1.1 percent.

The Fed's quantitative easing program, known as QE, has been key to the rally this year, helping push the benchmark S&P 500 up about 15 percent.

Some investors had speculated the Fed might backpedal from talk of cooling the pace of the bond purchase program, after comments from Bernanke last month threw a wrench in the equity rally and pushed Treasuries yields higher.

Investors across assets have built up trades around the Fed's stimulus program, using low-yielding Treasury debt as a source of borrowing for bets in riskier markets. Those bets become less profitable when Treasury market volatility increases as it has of late.

Since May 22, when Bernanke first addressed the idea of cutting bond purchases in the near-term, markets have seen an increase in volatility that is likely to continue. This has been evident in the sharp daily moves in markets such as Japanese stocks or emerging-markets currencies.

"When people put on these highly marginal or low conviction trades simply because of policy ... when they are unwound, you get dislocations that can be painful," said Michael O'Rourke, chief market strategist at JonesTrading in Greenwich, Connecticut.

"It's better (the Fed) at least slows the policy down or gives the test for the policy wind-down as he's done today, and it will get some people to start unwinding those trades. The market will hopefully start correcting quicker on its own without something more violent later."

The Dow Jones industrial average .DJI dropped 206.04 points, or 1.35 percent, to end at 15,112.19. The Standard & Poor's 500 Index .SPX fell 22.88 points, or 1.39 percent, to 1,628.93. The Nasdaq Composite Index .IXIC gave up 38.98 points, or 1.12 percent, at 3,443.20.

Benchmark 10-year Treasuries were last off 1-6/32 in price to yield 2.33 percent. The 30-year bond was 31/32 lower in price to yield 3.398 percent.

The slight upgrade to the Fed's economic projections also meant investors were gauging when interest rates could be raised.

"The forecasts suggested that the unemployment rate will fall to 6.5 percent in 2014, which means that the Fed could hike rates sooner than expected, possibly as early as the first quarter of 2015," said Camilla Sutton, chief currency strategist at Scotia Capital in Toronto. "And that's positive for the U.S. dollar."

The Fed has said it will keep rates at ultra-levels until the unemployment rate drops to at least 6.5 percent as long as inflation stays close to the Fed's 2 percent target.

Gold fell to a one-month low, with spot gold down 1.3 percent to $1,349.86 an ounce, the lowest since May 20.

Oil also fell after the Bernanke press conference. The front-month Brent contract was down 43 cents to $105.59, while U.S. crude fell 51 cents to $97.93.

(Additional reporting by Ellen Freilich; Editing by Dan Grebler and Chizu Nomiyama

Posted in:General
Posted by Gregg Mower on June 19th, 2013 3:08 PM



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