NEW YORK (TheStreet) -- Six years after the Federal Reserve rode to the rescue during the financial crisis, the central bank is ending its bond-buying program in October. While Fed Chairman Janet Yellen and the other Fed members don't plan to push interest rates higher soon, will the bond market do it for them?
Not likely. As the Fed stops pouring money into the economy to prop up the housing market and other assets, the bond market itself has actually been pushing rates lower and bond prices higher. That reflects caution -- in the short term, caution about Europe's flirtation with deflation and negative growth, and a longer term, concern that the U.S. is in for a sustained stretch of below-par growth. Since those concerns are likely to persist, interest rates that corporations and consumers pay are likely to stay really low for a long time.
"The market is actually worried,'' said Paul Edelstein, director of financial economics at IHS Global Insight. "When rates go down as they have, it has less to do with the Fed" and more to do with worries about the real economy, he said.
Futures markets say the Fed Funds rate won't hit 2%, up from today's near-zero range, until September 2017, says Andy McCormick, head of the U.S. taxable bond team at T. Rowe Price. The Fed's own projections show that rate going to 3% by then -- meaning the market is more cautious about the economy than the Fed is, he said. And the drop in 10-year yields this year, even as the Fed was winding down its $3 trillion bond-buying binge, indicates that big parts of the market are still betting on secular stagnation as a theme.
The argument: Years of underinvestment in new equipment and productivity growth have reduced the potential capacity of the U.S. economy, consigning growth to a lower range than it would otherwise be, Edelstein said. BlackRock bond strategist Rick Rieder made a similar point in a blog post in October. This argument may or may not be true -- the retirement of baby boomers may herald a long-term reversal of the lax labor market of recent years, and the boom in U.S. oil production plus the containment of health-care spending growth are powerful forces for stronger growth over time. However, the bond market is sending signals that it expects slower growth for a while longer.
That's one reason investors shouldn't expect a spike in real-world interest rates, like mortgage rates, similar to what happened last year, when former Fed Chairman Ben Bernanke suggested that bond buying might wind down sooner than expected. Another is that the Fed is not surprising the market with any fast moves, like Bernanke's remarks under questioning during a congressional hearing. The statement Wednesday, retaining the language that the Fed will wait "a considerable time" before raising rates reinforces the idea that central bankers want to see lower unemployment and higher middle-class wages before moving.
That's important because the recovery is still fragile enough that it can't easily tolerate any rate shocks. The jump in rates last year set back the housing recovery sharply, Zandi said -- new-home construction will be 20% less than the most-aggressive forecasts that were out there last fall. Key U.S. trading partners are still notably shaky. And higher rates could make current U.S. growth around 3% annually drop to closer to 2%, Zandi said.
The Fed knows this, and so does the bond market.
If Europe were to right itself suddenly, or U.S. data were to get dramatically better, this longer-for-lower theory might change. But for now, it's what the Fed wants -- and what the market expects.
This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.