Fed's "Range Bound"

By Rod Gonzalez

The historic move by the FOMC yesterday to cut the target Fed Funds rate by at least 75 basis points and proclaimed the new level to be in a range from 0.00% to 0.25%, The Fed’s decision to establish this “range bound” was a reaction to what Fed officials continued to call weakening conditions in the labor market and declines in production and consumption:

“The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability…weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time. The focus of the Committee's policy going forward will be to support the functioning of financial markets and stimulate the economy through open market operations and other measures that sustain the size of the Federal Reserve's balance sheet at a high level.” FOMC Release December 16, 2008

The Fed’s decision to act as aggressively as possible, coupled with indications that these historically low interest rates are here to stay drove investors to purchase longer dated maturities. As a result the Treasury’s benchmark 30 year bond (4.50% due 5/15/2038) surged by over five points at the close on Tuesday and has already added nearly three more points this morning. The yield has declined 32 basis points from Tuesday’s opening level of 2.945% to 2.63% this morning. Intermediate maturities were also in high demand (although not as aggressively) with the 10 year bond gaining 2 points 11/32s to yield 2.26%. The markets reacted positively to the “other measures” component of the statement as the Fed prepares itself to purchase considerable amounts of agencies and MBS in an effort to bring price stability in the mortgage and housing markets. The drastic drop in the long bond’s yield was also attributed to the Fed’s intention of buying long term treasuries in order to “influence yields on these securities, thus helping spur aggregate demand”.

Demand for Treasuries continue to be strong this morning with the 10-year bond gaining 1 point 12/32s to yield 2.12% while the 30-year has risen 3 points to yield 2.61%. Today’s release of the MBA Mortgage Application showed an increase in demand of 2.90% versus last week’s drop of 7.10%. The Bloomberg Global Confidence Index recorded a 6.10 reading while the Current Account Balance showed -$174.1B versus the expected -$179.0B. The lack of Tier 1 economic releases means that investors will pay attention to other factors such as energy prices (to continue to evaluate inflationary expectations). There is an OPEC conference being held in Algeria today where the organization intends to announce a daily 2 million barrel cut in production in order to stabilize oil prices.