Treasury Investors Worry About Federal Reserve Danger

4798Ahead of a Wednesday policy statement from the U.S. Federal Reserve, worries are growing over how long the central bank will sustain its bond purchasing and the potential effect on the long-running rally.
The Fed's bond-buying programs, started in late 2008 and designed to boost economic growth by keeping rates low, have been the main support for U.S. Treasurys prices, which move inversely to yields. With recent data showing improving U.S. labor and housing markets, investors have been selling these haven assets.

Any talk of reining in the Fed purchases will hit a nerve with bondholders. They don't want to be the last investors holding Treasurys when the Fed slows or stops buying and prices fall.

This growing discomfort was highlighted on Jan. 3, when Treasurys sold off sharply after minutes from the Fed's December meeting revealed that several policy makers think it could be necessary to curb the program before year-end.

"The minutes threw some things into question," said Greg Faranello, Treasurys trader at Société Générale GLE.FR -2.63% in New York, who still sees the Fed buying aggressively for a year or more. "But it's self-fulfilling. At some point, the market has to take credence in the fact that the Fed is getting successful in strengthening the economy."

In December, the Fed extended a $45 billion-a-month commitment to buy Treasurys until it is satisfied with conditions in the U.S. labor market. Analysts widely expect the Fed to uphold the existing policy at this week's meeting.

But investors will be digging deep for hints about when and how the Fed plans to withdraw from the market.

The Fed statement out Wednesday will be important in assessing policy makers' state of mind, as will the next monthly nonfarm payrolls report due Friday. Economists expect 168,000 private-sector jobs will have been added to the economy in January. The unemployment rate, which is calculated separately, is expected to hold steady at 7.8%.

The focus on the labor market and Fed exit strategy is especially important as other key sources of market support dissipate as the European debt crisis stabilizes and U.S. lawmakers sort out some aspects of the federal budget.

The House of Representatives passed a bill on Wednesday to suspend the U.S.'s legal debt limit, allowing the country to borrow more and pay its bills. As such uncertainties abate, the Fed is left as the main pillar propping up U.S. Treasurys.

Jan Hatzius, chief U.S. economist for Goldman Sachs, GS -0.22% expects a discussion about the end of bond purchases to be on the Fed's agenda at this week's meeting. He sees the central bank eventually setting criteria for ending the program, with a 7.25% unemployment rate and a 2.5% upper boundary for inflation expectations. Consumer prices rose 1.7% in 2012.

Source: Wall Street Journal | CYNTHIA LIN
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