Podcast: August 2010 Federal Open Market Committee Meeting

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

Welcome, my name is Sean Simko. I am Managing Director of SEI Global Fixed Income Management. Today’s commentary will focus on the August 10 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 two-day closed-door meeting and as expected, the Committee left the lending rate unchanged, holding it in the range of zero to 25 basis points. Although divided by its members’ opinions, the FOMC didn’t disappoint the market. Federal Reserve Bank of Kansas City President Thomas Hoenig remains the hawk of the Committee, dissenting for the fifth consecutive meeting and voting against the Committee’s decision to reinvest principal payments from its balance sheet assets in Treasuries. Federal Reserve Bank of St. Louis President James Bullard pushed for a second round of quantitative easing, while other Committee members were in a wait-and-see mode. The biggest problem with these divisions is a potential for the loss of the Fed’s credibility. Chairman Bernanke needs to show that he remains in control of not only the economic environment but also of his Committee. The overall tone of the statement was cautious, with comments such as “household spending is increasing gradually but remains constrained by high unemployment, modest income growth, lower housing wealth and tight credit.” The committee discussed further quantitative easing, or bond-buying programs, which was what the market was looking for. Economists are referring to this as “quantitative easing light,” since it’s a smaller effort than the bond-buying programs initiated during the credit crisis.

The Treasury market continued to rally on the heels of mixed economic data that reflected the economy is showing signs of decelerating. The quantitative-easing language confirmed the weaker view and addressed deflationary concerns, which helped support the Treasury rally, pushing prices higher and yields lower. The entire curve rallied on the news, with the five- and seven-year points on the curve leading the way. The five-year closed the day at 1.44%, approximately 8 basis points lower. The seven- and ten-year yields moved 9 and 7 basis points lower to close at 2.12% and 2.75%, respectively.

The Fed is trying to avoid a scenario like Japan’s “lost decade,” marked by deflation, low consumer confidence and almost no economic growth. Inflation was once thought to be the next headache for the Fed but has recently fallen by the wayside due to deflationary concerns. The labor and housing markets have not truly turned the corner either, which isn’t helping the situation. The Committee addressed all these issues during its meeting and has devised a plan of attack. We will have to wait and see if enough ammunition is being used or if the Committee will need to increase its efforts.

The August meeting confirmed our view that the Fed will remain on hold for the foreseeable future. It is uncertain as to whether the FOMC will need to increase its quantitative-easing efforts. The action reflected in the Treasury market signals that abnormally low interest rates will likely remain into 2011. We maintain the view that the economy is stabilizing but decelerating. Because of this environment, we continue to favor higher-quality assets.

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