Chart of the Week: How the Bond Market Prices In Fed Policy

Jeffrey DeMaso

Portfolio Manager

Traders and investors spend a lot of energy trying to predict the Federal Reserve’s actions. The Fed also spends a fair amount of effort telegraphing what it is planning to do; an unwritten policy is to try to avoid “surprising” the market. The result? By the time the Fed acts, bond traders have more often than not already priced in the move.

You can see this in the chart below, where I’ve plotted the yieldYield is a measure of the income on an investment in relation to the price. There are several ways to measure yield. The current yield of a security is the income over the past year (either dividends or coupon payments) divided by the current price. of the three-month Treasury bill alongside the fed funds rate (specifically, the upper bound of the Fed’s target range). The two rates largely move together—no surprise there. The key insight, though, is that the T-Bill’s yield leads the fed funds rate.

So the Fed hiking rates yesterday made headlines, but for bondA financial instrument representing an IOU from the borrower to the lender. Bond issuers promise to pay bond holders a given amount of interest for a pre-determined amount of time until the loan is repaid in full (otherwise known as the maturity date). Bonds can have a fixed or floating interest rate. Fixed-rate bonds pay out a pre-determined amount of interest each year, while floating-rate bonds can pay higher or lower interest each year depending on prevailing market interest rates. investors it was already old news.