Podcast: January 2010 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 Federal Open Market Committee, or FOMC, meeting held on January 27, including the release of the Committee’s statement and the market’s initial reaction.

Plain and simple, there were three points that needed to be covered by the FOMC. First, the Committee needed to provide comments around inflation and confirm that the inflation environment remains benign. Second, language in the FOMC’s statement around the intent of the Committee to hold rates at a low level for an extended period of time needed to remain intact. And lastly, it was necessary to confirm that the economy continues to strengthen and that the Committee remains cautiously optimistic regarding the economy. Clarity and confirmation were delivered, providing investors with conviction that the Fed will maintain its current view.

The FOMC concluded its scheduled closed-door meeting on Wednesday, providing a statement that was very similar to the last. Although the content was similar, the tone could be looked at as dovish or hawkish depending on the focus of the reader. As expected, the Committee left the lending rate unchanged, holding it in the range of zero to 25 basis points. What was unexpected was the dissent from Kansas City Fed President Thomas Hoenig. While Mr. Hoenig did not want to raise interest rates, he believed current economic conditions warranted the removal of the previously issued statement about keeping interest rates low for an extended period of time. Mr. Hoenig’s hawkish opinion aside, the Committee decided to keep the language, reassuring market participants. The Committee did restate that there are signs that economic activity is improving and that “labor market deterioration is abating.” We strongly feel that visible signs of job growth would push the Fed to raise interest rates. If the unemployment rate remains high, the Fed will continue to hold the federal funds rate at its current range for the foreseeable future.

The FOMC reaffirmed that it will end the $1.25 billion mortgage-backed securities purchase program at the end of the first quarter and will unwind the other accommodative measures when the time is right. In the end, the statement provided the information investors were seeking.

Treasuries rose early in the morning on the heels of sovereign debt concerns. Greece continued to remain in the headlines, as spreads widened and the cost of protection from default moved wider. The move within the Treasury market is a reminder of how fragile the market environment really is. Approaching midday, Treasuries gave back roughly half the day’s gains, with the 10-year settling in at 3.60% ahead of the FOMC statement release.

The reversal within the Treasury market happened abruptly. The initial rally quickly turned into a sell-off, as the tone shifted from a flight to quality to a demand for riskier assets. The move coincided with the release of the FOMC statement; however, we believe the statement did not drive yields higher. Instead, minor improvements to the economy added to the pressure from rallying equity markets, driving yields higher for the day. The ten-year sold off from 3.60% to close the day at 3.66%, which was only modestly higher than its closing level of 3.65% the day before. Although we believe the dissenting vote was not the primary driver of higher yields, it did help flatten the curve. We saw the curve between the two-year and ten-year flatten 9 basis points, and the curve between the two-year and five-year flattened 6 basis points.

Looking forward, we believe Treasuries will continue to trade with violent swings. Movements will be choppy with an upward bias in yields throughout the first quarter. We expect the trend of higher rates to emerge once again as we move through the economic recovery, and as the onslaught of political pressure directed toward the Financials sector abates. We continue to hold our view that the economy is stabilizing although it remains fragile, and we remain cautious with respect to the pace of future economic growth.

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