If you're looking to judge the success of the Federal Reserve's latest monetary policy initiative, look at the Treasury market, not the stock market.
Those wondering how low interest rates could go on two-, ten- and even 30-year Treasurys could go, now you have an answer.
"Lower than anyone thought 24 hours ago," quipped Jim Awad, managing director at Zephyr Management. It creates "a rally in the Treasury market from here."
"It keeps the trend in place," sad Scott Anderson, senior economist at Wells Fargo. "It's still safe to be a holder in the Treasury market
And rally they did, adding to earlier gains based on new signs of economic weakness and the hope the Fed would pull the pin. Yields at the intermediate- and long-endof the market sank with the 30-year bond breaching 4.00 percent.
The Fed left no doubt about its intentions in its policy statement, saying it would reinvest "principal payments from agency debt and agency mortgage-backed securities in longer-term Treasury securities...and continue to roll over the Federal Reserve's holdings of Treasury securities as they mature."
Some have been speculating that the Fed might resume and/or expand a massive program to buy agency and MBS debt that ended March 31. But using its considerable fire power on the Treasury market makes more sense at this point in a stubbornly tepid recovery.
"The Fed doesn't have a lot of ammunition left," said veteran fed watcher David Jones of DMJ Advisors. "They're saying with housing, 'There's really no more we can do.' "
The Fed's year-long program to purchase up some $1.45 trillion in agency and mortgage debt is considered one of the most successful of its unconventional policy initiatives, which has provided something akin to life support to the housing market.
"This is more than a symbolic move," said Anderson. "The ten-year Treasury is the benchmark. It's the biggest lever it could pull."
In other words, any decline in the 10-year yield would be reflected in mortgage rates.
The Fed's move also essentially says its safe to continue to invest in Treasurys if only because the Fed itself is.
"Piggyback on the Fed," said Jones.
"The Fed is saying, 'We going to do to long rates what we did to short rates—take them as close to zero as we can and hope that it works,'" added Awad.
Even before the Fed's move Tuesday, some big institutional investors were said to to making bets on long-term Treasurys on the assumption that investors would continue to flock to the safety of government bonds, sending rates even lower.
Given the market's initial reaction, the move appears to be a success but investors may wake up with second thoughts on the latest Fed-to-the-rescue initiative.
"It may only stick for one day," said Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi. "We'll see how far this goes; yields are getting pretty low. At 2.75 percent you lose your natural base of investors,"
Rupkey recalls that the Fed's announcement last March that it would buy up to $300 billion in Treasurys over six months had a short-lived effect. The yield on the 10-year briefly fell below 2.60 percent before springing back.
The Fed certainly won't have to wait long to be tested with big 10- and 30-year auctions scheduled Wednesday and Thursday.
The real success, however, won't be visible for some time.
"The Fed is basically begging the banks and businesses to spend," said Anderson.