Podcast: March 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 March 16 meeting of the Federal Open Market Committee, or FOMC, including the release of the Committee’s statement and the market’s initial reaction.

The FOMC concluded its scheduled closed-door meeting on Tuesday, providing a statement that was similar to its last one. However, there were minor changes that carried a modestly hawkish tone. As expected, the Committee left the lending rate unchanged, holding it in the range of 0 to 25 basis points. The expectation was for Kansas City Fed President Thomas Hoenig to dissent again in recommending changing the extended period language. Mr. Hoenig did not disappoint, but his comments did not roil the market in any way. The Committee decided to keep the language around keeping the federal funds rate “exceptionally low” for an “extended period,” reassuring market participants. The Committee gave a modest upgrade to the labor market and overall economic conditions. It did state, however, that “employers were reluctant to add to payrolls,” which coincides with our view that the next crucial step is job growth. The message from this and prior statements is that there is no immediate pressure for the Committee to raise the overnight federal funds rate if inflation remains subdued.

The market’s reaction to the statement was muted. The Treasury started “Fed” day in similar fashion to the prior day’s action. Volume and activity were generally light. Unlike the prior meeting, when sovereign concerns were significant, they were less of an event this time around. Early morning, demand increased for Treasuries when housing starts disappointed. Approaching mid day, Treasuries started to give back some of the morning gains, with the 10-year settling in at 3.68% ahead of the FOMC statement release. As a point of reference, the 10-year was trading at 3.60% prior to the January statement.

The Treasury market’s tone held firm upon review of the statement. The move showed conviction that the market is in agreement, inflation is not a concern and rates will remain range bound. The 10-year was little changed from its 3.68% level, closing the day at 3.65%. The Committee is likely to take a mechanical approach and, at this point in time, the Treasury market is not fully pricing in this move.

We are cautiously optimistic about the economic recovery and future Federal Reserve (Fed) actions, waiting to see if the positive data and trends are sustainable. Economic data continues to show improvements, which has led to the Fed’s upgrade of its view on both the labor market and the economic recovery and should ultimately mean a change in its policy stance. On that note, the Committee is moving toward a decision to remove its language around keeping rates low for an “extended period,” but the time is not yet upon us. The earliest this language could be changed is at the meeting on April 28, but we believe it will most likely not change until the June 23 meeting. Even then, the language will likely be altered, not completely dropped. This would be similar to the policy shift that occurred from 2003 to 2004, when Alan Greenspan began softening statement language from saying that the Fed would keep accommodative efforts in place for a “considerable period” on December 9, 2003, to saying it could be “patient” in removing its policy accommodations on January 28, 2004. If recent history is any indication of a future policy roadmap, we will likely see a three-step approach before actual tightening. A softening of the “extended period” language would occur, followed by this softened language being dropped and finally, rates would be tightened. Following this outline, September is the earliest we feel the Fed will remove its accommodative policies through increasing the federal funds rate.

Looking forward, Treasuries will continue to trade choppy. Although range bound, we continue to have an upward bias in yields. We expect the trend of higher rates to continue to emerge as we move through the different stages of the economic recovery. We maintain the view that the economy is stabilizing, although questions remain about the sustainability of strong growth.

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

SEI Global Fixed Income Management manages fixed-income strategies for SEI’s Managed Account Program (MAP) and Integrated Managed Account Program (IMAP).