The Bond Market Tells The Fed What To Do, Not Vice-Versa

Photo Credit: Tulane Public Relations || James Carville wants to be "reincarnated" as the bond market, to scare everyone -- boo!

Photo Credit: Tulane Public Relations || James Carville wants to be “reincarnated” as the bond market, to scare everyone — boo!

I was reading this article at Reuters, and musing at how ludicrous it is for the Fed to think that it can control the reaction of the bond market to tightening Fed policy, should it ever happen.  The Fed has never been able to control the bond market, except on the short end, and only with the highest quality paper.

The long end is controlled by the economy as a whole, and its rate of growth, while lower quality bonds and loans also respond more to where the credit cycle is.  The Fed has never been able to tame the credit cycle — the boom and the bust.  If anything, they make the booms and busts worse.

Now they think that their new policy tools will enable them to control the bond market.  The new tools are nothing astounding, and still mostly affect short and high quality debts.

One thing is certain — when the Fed starts tightening, some levered parties will blow up.  Even the mention of the taper caused shock waves in the emerging bond markets.  And when something big blows up, the Fed will stop tightening.  It always happens, and they always do.

So please give up the idea that the Fed can do what it wants.  It looks like it can in the short-run, but in the long run markets do what they want, and the Fed has to respond, rather than lead.