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Jeff's Investment Corner

Rates continue to press higher. Since my last report, the 10-year yield has moved from 2.60% to 2.85%. The declared reason for this rate adjustment is an increased likelihood that QE tapering will begin at the upcoming September 18 FOMC meeting. The Fed may not actually begin to taper their current bond purchases the day after the meeting, but they will very likely announce the terms for how QE tapering would unfold.

When QE Infinity was first announced, the Fed did not set an end date for the program, nor did they declare how many total bonds would be purchased. We all knew that the party would have to end sometime, but did not know what would cause it to end. Then the Fed told us that there were thresholds for the unemployment rate (6.5%) and inflation (2.5% trending) that would be used to let the Fed know when QE would stop. Yet in May, when various Fed Presidents took to the podium to openly discuss the end of QE, neither of these thresholds were even close. Bernanke himself added to the confusion in his testimony before Congress and later in a press conference following the June FOMC meeting. He surprised the markets by going along with the idea that QE tapering would commence before the thresholds were approached. He took pains to split QE bond purchases from a change in the fed funds rate. QE bond purchases could end a lot sooner (maybe this year) than the fed funds rate might start to rise (maybe not for two years).

Bond prices nosedived in May and June, stabilized in July, and are heading lower again in August. Bond investors have decided the Fed is just making it up as they go along and voted with their feet, exiting bond funds in record numbers.

This is putting upward pressure on mortgage rates. Whether the higher rates are sufficient to blunt the current momentum in the housing market is still an open question. Rates have only jumped up these last few months. The jury is still out as to how this will impact home affordability.

The Great Bond Bull market that started in 1981 is over. It was a great 30-year run, but the low watermark for rates will be identified as occurring in July 2012. So we have actually been working towards higher rates for over a year now. The pace of that adjustment has only recently accelerated. I think the current move has gone too far, but we had better get used to a steady diet of rising rates for the foreseeable future.

Jeff Smith
Director of Investment Sales

Jeff's comments and insights, based on his professional expertise and the knowledge he has acquired observing the U.S. economy and global markets, are offered as his own personal observations and opinions, and not necessarily reflective of those held by SunCorp, our board or member credit unions.

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