The Fed calls the tune in bond markets QE "infinity" has arrived - and with it a whole new set of challenges for fixed income investors. If there was any doubt before about the Federal Reserve's commitment to drive investors into riskier assets, Ben Bernanke has dispelled it. Bond dealers now face the reality of a US central bank prepared to keep buying unlimited amounts of bonds, in particular mortgage-backed securities, until a substantial recovery is under way in the US. This has huge implications for debt, credit markets and other assets. The bond market is pretty much a creature of the Fed. They are calling the tune," says Jay Mueller, portfolio manager at Wells Capital Management. An important objective of the Fed's bond purchases is to propel investors out of Treasuries and mortgages into riskier assets, such as corporate debt, loans and structured assets. These are all areas of fixed income that have already performed well this year. Equities are another beneficiary. Both the Fed's move and the Bank of Japan's decision on Wednesday to step up its asset buying programme have been supportive. Like other risky assets, stocks are sitting on solid gains for the year to date. New York's benchmark S&P 500 index is up 16 per cent since January. But there are considerable headwinds for equities. Amid a slowing global economy, faltering corporate earnings, the prospect of automatic US budget cuts - the so-called "fiscal cliff" - and a continuing crisis in the eurozone, one question is whether central bank liquidity can paper over such problems. "Credit markets and risk assets in general are pricing in no policy mistakes," says Stephen Walsh, global chief investment officer at Western Asset Management. Indeed, since the Fed launched "QE3" last week, Western has been cutting exposure to areas of the credit market and placing the proceeds into Treasuries as a precaution, despite historically low yields on US sovereign debt. "No one thinks that a 1.80 per cent yield [on a 10-year Treasury] is a good investment, but you still need to have some insurance in your portfolio," says Mr Walsh. True, inflation expectations have jumped sharply and higher inflation would erode the value of bonds paying out fixed returns. Fears of an inflationary surge could put upward pressure on longer-dated Treasury yields. These are more influenced by expectations of inflation, particularly should investors emulate the post-QE2 period of late 2010 and sell their government bond holdings. "My concern is that it may take weeks, months of contrary data to calm investor fears about inflation and that it will be difficult to put that inflation angst to rest," says William O'Donnell, strategist at RBS Securities. But Rick Rieder, chief investment officer for BlackRock says the argument that the Fed's "dramatic" stimulus will lead to much higher inflation has been overstated. In any case, it would take a bold investor to take on a more aggressive Fed in expectation of higher Treasury yields and inflation. "Unlimited QE means the bond market must confirm to what the Fed wants to do unless they lose their credibility," says Mr Mueller. When you are pushing fiat money it's all a matter of belief, but we can all see what has happened to Greece. Meanwhile, the open-ended nature of QE3 will lead to the Fed playing an even bigger role in the treasury and mortgage markets. Of the $2.6tn of securities held by the central bank, Treasury debt accounts for $1.64tn and mortgages $844bn. The implications are clear. As the Fed's presence grows and compresses volatility in interest rates, becoming effectively the only buyer left in these markets, investors may struggle to find profitable trading opportunities, says John Brady, senior vice-president at RJ O'Brien. Under QE3 and its current reinvestment of mortgage coupons, the Fed will be buying some $65bn of mortgages per month, more than half monthly new issuance of $20bn-$30bn this year, according to Dealogic. The central bank's huge presence has sparked a big rally in mortgage security prices in the past week, providing a windfall gain for investors such as Bill Gross at Pimco, who anticipated QE3. Philip Barach, president of DoubleLine Capital, says the effect of QE3 can be seen in mortgage spreads, which are inside 100 basis points for the first time since 1992. He expects yields to continue tightening. Jeff Moore, co-manager of the Fidelity Total Bond Fund, predicts the biggest beneficiaries of QE will be instruments leveraged to an increase in asset prices, including commercial mortgage-backed securities and bank debt. "We are gone from the days of the two-sided market, where there was lots of debate and buyers and sellers," says Mr Moore. Now you have to be either neutral or long. Reporting by Michael Mackenzie, Stephen Foley and Dan McCrum in New York