Friday's Market Minute: The Competition For Yield Heats Up

The Fed raised its policy rate again this past Wednesday to levels not observed in over two decades. At the center of the interest rate debate is core Personal Consumption Expenditures (PCE) inflation, which at 4.6% remains markedly above the Fed's 2% target. While inflation has made some meaningful improvements since the last meeting, the Fed acknowledged that price levels remain elevated. Meanwhile, economic growth remains notable, allowing the Fed flexibility for the option of future rate increases.

In tandem, the European Central Bank raised the Eurozone reference rates by 25 basis points yesterday and equity markets eventually closed lower after the 10-year Treasury yield rose to over 4%. The sudden rise in long bond rates was not due to the expected increases put forth by the Fed and ECB, but rather the Bank of Japan (BOJ) which made an adjustment to its longstanding yield curve control policy of upholding an interest rate cap on 10-year debt. 

Under the previous mandate, the BOJ would buy whatever amount of Japanese government bonds necessary to ensure their 10-year yield remains below 0.5%. Markets were struck by a moment of fear yesterday as the BOJ stated their intent to keep the implied 10-year target at 0.5%, but will allow flexibility for the yield to rise as high as 1.0%. This slight amendment in the target range matters because the accommodative policy has been utilized by traders and institutional investors for years as means to borrow cheap Japanese yen and invest in overseas stocks and bonds for a higher return. Therefore, a sudden change in the interest rate cap led to a selloff in global stocks and bonds as traders rushed to cover their carry trades by buying back Japanese yen.

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