ANALYST: The Bond Market Has Already Priced Tapering, Now The Question Is: How Much More Damage Will There Be?

ben bernanke

Yields on U.S. Treasuries have soared since May 3 as bonds have sold off and investors have yanked money out of bond funds, driven by fears that the Federal Reserve would begin to signal tapering back of the bond purchases it makes under its quantitative easing program of monetary stimulus sooner rather than later.

Today, the Federal Reserve Chairman Ben Bernanke had the opportunity to push back against the rise in rates and allay market volatility, which is exactly what the market consensus expected of him.

Bernanke ended up doing the opposite – he essentially encouraged the rise in yields, saying it was for good reasons – and investors began dumping bonds, sending the yield on the 10-year Treasury note to 2.35% at the close, up 14 basis points from where it was before the release of the FOMC monetary policy statement and subsequent Bernanke presser this afternoon.

The natural question, as UBS economists led by Maury Harris put it, is this: How much more bond market damage?

Harris and his team actually think Fed tapering has already been priced into the market:

The benchmark 10-year Treasury note yield already has risen from 1.66% at the start of May to 2.35% soon after the Fed’s latest communications. As earlier mentioned, we have raised our 10-year Treasury note yield forecast for year-end 2013 by 30 basis points to 2.5% but are maintaining our 2.8% forecast for the end of 2014. Why not more damage than that to an already damaged bond market? Most importantly, we think that the bond market already has priced in tapering. Second, the Fed is reiterating that it will not even consider raising the Federal funds rate until unemployment is at a 6.5% threshold. Also, Bernanke’s theory that bond yields will reflect how much securities the Fed holds (the “stock” theory) versus how much they buy (the “flow” theory) probably has at least some, albeit quite controversial, validity.

If that’s the case, maybe the bond market has already put the scariest part of the tapering story behind it.

Business Insider Emails & Alerts

Site highlights each day to your inbox.

Follow Business Insider Australia on Facebook, Twitter, LinkedIn, and Instagram.