Podcast: December 2011 Federal Open Market Committee

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

December 13 marked the eighth and final FOMC meeting for 2011. Although the U.S. economy strengthened over the course of the year, there were many exogenous events that created shockwaves throughout the system and placed a heavy burden on the FOMC. The new voting members provided fresh views for market participants to digest. For the Committee, the year ended similarly to how it began—with economic growth visible, but moving at a slower pace than everyone would like to see.

As we enter 2012, we expect the FOMC to stay on path with its current views and objectives. Unless there is a shock to the system, do not expect changes anytime soon. U.S. economic data has improved, providing the Fed with a cushion and the ability to remain on the sidelines a little bit longer. Right now, the U.S. economy is healthier than it was at the start of the year. But while the economy may be stronger and seemingly insulated from the European debt crisis, the U.S. financial system is not completely immune. The wild card is the ongoing uncertainty and the troubles that may arise from within the European financial system, and the implications they may have on the global banking system.

The Fed continues to move toward greater transparency, as Federal Reserve Chairman Ben Bernanke has indicated that his view is to increase clarity around the Committee’s forecasts. This should help to align market expectations. With gradual economic growth and low inflation, there was not a dire need to change policy at the FOMC’s most recent meeting.

The FOMC concluded its scheduled meeting on December 13 and, as expected, left the lending rate unchanged, holding it in the range of zero to 25 basis points. Unlike prior meetings, this one did not introduce any new shocks to the system. The Fed stated that, “The economy has expanded moderately, notwithstanding some apparent slowing in global growth.” The Committee also stressed that the pressures within the global financial system continue to weigh on the economy. In regard to the labor market, the statement read that, “While indicators point to some improvement in overall labor market conditions, the unemployment rate remains elevated.” The Committee did not alter “Operation Twist.” It also reiterated that it will continue to reinvest its principal payments from its holdings into the agency mortgage-backed market. Chicago Fed President Charles Evans was again the sole dissenter, holding a dovish perspective and looking for more accommodation.

The Treasury market remains stuck in the recent range. Overall volumes are light as thin trading creates exaggerated moves. This environment is expected to remain intact as we approach yearend. Prior to the release of the statement, the yield curve showed signs of steepening as the long end sold off and the front end was anchored by Fed policy. With the Fed holding rates firm and commenting that downside risks remain, the curve reversed its move to a flatter bias. The 10- and 30-years rallied, pushing the yields lower by 5 basis points to 1.95% and 2.98%, respectively. The front end of the curve held firm as the Fed reiterated its goal to hold rates exceptionally low through mid-2013.

The December meeting came and went quietly and under the radar. Once again, concern about the labor market and more focus on the European debt crisis kept the possibility of future accommodation alive. At this point, we maintain the view that the economy is showing signs of stabilizing, with marginal growth prospects. We also expect volatility to remain present as we continue to dissect the European sovereign default risks.

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

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