Fed bond buying may end placidly

By Chris Reese

NEW YORK (Reuters) – The Federal Reserve’s scheduled end of Treasuries purchases in the middle of the year may remove the market’s biggest buyer, but it doesn’t necessarily mean bond prices will sink dramatically, analysts said.

The Fed on Wednesday is scheduled to buy $1.5 billion to $2.5 billion of Treasuries maturing August 2028 through February 2041 as part of their $600 billion bond-buying program dubbed QE2, which is slated to end at the end of June.

Minutes from the Fed’s last policy meeting on March 15, released on Tuesday, confirmed for many analysts that the central bank will complete the program as planned, and will not terminate it early as some Fed officials had called for last week.

“The minutes of last month’s meeting provide further evidence that the Fed will complete QE2 in full by the end of June,” said Paul Dales, senior U.S. economist at Capital Economics in Toronto, adding “the big question is what happens when QE2 ends?”

Dales does not expect the Fed putting its wallet back in its pocket to hit Treasuries hard, although it could impact other markets.

“We doubt Treasury yields will rise sharply. In fact, if the end of QE2 triggers an easing in inflation fears, as was the case once QE1 concluded, Treasury yields could fall,” he said. “At the same time, we wouldn’t be surprised to see the completion of QE2 bring a halt to the upward trends in equity and commodity prices and the downward trend in the dollar.”

“As for the real economy, more important will be the fading of the fiscal stimulus and the adverse impact on real incomes and real spending from higher energy and food prices that will contribute to a slowdown in economic growth in the second half of the year.”

Others are hoping at least a tepid economic recovery will take up some of the slack from the Fed pulling out of the bond market, and that rates will rise gradually.

“June is not that far off, but if we were to see improvement in the economy and particularly in the labor market, people would be comfortable with QE2 coming to an end,” said David Coard, head of fixed-income sales and trading at The Williams Capital Group in New York.

“I don’t see anything dramatic — everybody knows that it is ending in June and the expectation was with QE2 the Fed was helping to support the economy, and you would think that the economy would be in better shape and rates would be continuing to rise,” Coard said.

Treasury debt yields have risen since the Fed announced QE2 in early November, when it said it was undertaking the program “to promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate.”

Benchmark 10-year Treasury note yields on Thursday were trading near 3.49 percent, up from 2.59 percent in early November.

The Fed has bought about $570 billion of Treasuries and Treasury inflation-protected securities under QE2 and a previous program which began in August using funds from maturing agency bonds and mortgage-backed securities.

(Editing by James Dalgleish)

Fed bond buying may end placidly