Podcast: December 2009 Federal Open Market Committee Meeting and Initial Market Reaction

Welcome, my name is Sean Simko. I am Managing Director of SEI Global Fixed Income Management. Today’s commentary will focus on the December 16 meeting of the Federal Open Market Committee, or FOMC, including the release of the Committee’s statement and the market’s initial reaction.

Expectations within the investment community were pretty much unanimous that the Committee would leave the overnight lending rate unchanged at the range of zero to 25 basis points. Since this was already widely anticipated, investors were really looking for clarity and guidance. Regardless of whether this is Act 2, 3 or 4 in the ongoing economic show, the trend is clear: market participants want direction on the state of the economy, inflation and most importantly, clarity on the Fed’s commitment to hold rates low for an “extended period.”

Fed members (including the Chairman) have provided views on future rate hikes, inflation and the labor market. For the most part, the comments from the Fed have been dovish, with greater emphasis on the downside risks of unwinding its accommodative policy too soon. Even as central banks around the globe continue to tighten their monetary policies, the FOMC is not likely to follow suit in the near term. Our view is that there is no rush for the Fed to start raising interest rates. There is significantly more immediate downside risk if they move too early, particularly since inflation remains low. If stimulus is removed too quickly, it would be a recipe for deflation—a problem this economy does not need. While an accommodative monetary policy does not create inflation, it generates excess cash in the system that has the potential to create inflationary pressures. However, this occurs only if credit is made available.

The FOMC concluded its scheduled closed-door meeting on Wednesday, once again providing a statement very similar to its last. The Committee decided to keep the language around keeping the federal funds rate “exceptionally low” and statements that rates will remain “low for an extended period.” The Committee recognized that there are signs that the economy is improving, with comments supporting a modest upgrade within the labor market. In the end, the statement provided the information investors were looking for.

The Treasury sector traded better with a slight rally in the early part of the morning, reversing its recent trend. Market swings have been exaggerated due to the thinner markets as we approach year end. Recent comments about improvements in the economy and uncertainty about the timing of future Fed actions have been weighing on the markets, resulting in pronounced moves. We believe this is unlikely to end any time soon.

The release of the statement did not change the recent trend for Treasuries. Yields continued to inch higher after the release. Minor upgrades to the economy and the labor market are just enough to keep Treasuries under pressure. Shortly after the announcement, the five-year traded at 2.34%. The ten-year sold off, pushing the yield up to 3.60%. The yield curve steepened modestly, led by the front end, as it remained anchored by the language that was left in the statement around keeping rates exceptionally low for a prolonged period of time.

Looking forward, Treasuries are likely to trade in a choppy manner with an upward bias in yields. We expect the trend of higher rates to continue as we move through year end. With that said, I want to clarify that rates are not going to move higher in a straight line. Instead, they are likely to bounce up and down from data point to data point and Fed speaker to Fed speaker. We continue to hold our view that the economy is stabilizing, and we remain cautious with respect to the economy’s future growth prospects, which hinge on when companies will start to hire more workers.

If you have any questions regarding this podcast or the markets, please contact your SEI representative.