How Central Bank Policy Impacts Asset Prices Part 2: Bonds
The Fed sees the need to reduce interest rates as it takes over the US Treasury and MBS markets; but the ECB's actions are more aimed at reducing divergences between peripheral nations and the core. As SocGen notes, it remains unclear how and when the Fed would exit this situation and in Europe, bond market volatility remains notably elevated relative to the US and Japan as policy action absent a political, fiscal, and banking union remains considerably less potent.
Fed action pushes rates to record lows
The Fed bought around $2tn of securities since November 2008, pushing rates to historical lows (US treasuries becoming popular safe havens also contributed to lowering rates).
It remains unclear how and when the Fed would exit this situation. Operation Twist expires at year-end and any extension seems to be put on hold until after the presidential elections.
A potential Romney victory could bring an end to low QE rates in 2014 (when Mr Bernanke’s term expires).
As a result of the very low rate environment, the US equity risk premium is currently extremely high (6.3% in October 2012).
Hurdles in transmission of ECB monetary policy
Yield spreads divergence between peripheral countries and the rest of the eurozone illustrates the difficulties the ECB faces in performing its policy in the absence of a political, fiscal and banking union.
Since end-2011, unconventional measures from the ECB have had a significant impact on rates. The launch of OMT could see peripheral rates tighten even further.
However, bond market volatility in the euro area remains high compared to the US and Japan even though it has decreased recently.
Provided that Mr. Rajoy requests a bailout as expected, rate normalisation should continue, especially after Germany’s election in September 2013.