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"Control of Interest Rates" is the Biggest Myth About the Federal Reserve
Bond investors need to prepare for a major change of trend

By Bob Stokes
Thu, 31 Jan 2013 16:45:00 ET
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When Ed Koch was the mayor of New York City, he made it a habit to stop people on the sidewalk and ask, "How am I doing?" 

Sometimes the cameras were rolling during these exchanges. Many people simply replied "Great!" Koch often kept walking, putting the same question to the next individual or small group he saw.
 
In contrast, Federal Reserve policymakers don't stroll sidewalks and solicit job reviews from constituents. Even so, we can assess how Fed policy is doing.
 
Consider this excerpt from the Fed's most recent policy statement.
 
The [Federal Open Market] Committee will continue purchasing additional agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month. The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. Taken together, these actions should maintain downward pressure on longer-term interest rates. ... [emphasis added]
 
In September 2012, the Federal Reserve's QE-3 statement also mentioned the aim of a "downward pressure on longer-term interest rates." But look what has recently happened to the yield of the 30-year U.S. T-Bond. The chart is from the Jan. 30 Short Term Update (labels removed).
 
  
 
As you can see on the chart, the long-bond yield has actually trended upward since Nov. 16.
 
Many observers of financial markets hang on the Fed's every word, and believe the central bank determines interest rates.
 
Regardless of assertions to the contrary, the Fed’s purported “control” of borrowing, lending and interest rates ultimately depends upon an accommodating market psychology and cannot be set by decree. So ultimately, the Fed does not control either interest rates or the total supply of credit; the market does.
 
Conquer the Crash, second edition, p. 127
 
And the bond market is at an historic juncture.
 



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