Muddled Fed Message and Stronger Economic Numbers Cause Interest Rate Volatility

Over the last month the bond market has struggled with what to expect from future monetary policy, as expectations for future bond buying from the Fed are called into question.  Remember that on May 1st the FOMC issued a statement after their meeting stating that  the Committee was “prepared to increase or reduce the pace of its purchases to maintain appropriate policy accommodation as the outlook for the labor market or inflation changes.”   The market took this as a sign that the committee was concerned that economic growth could weaken and was preparing to increase asset purchases, causing yields on 10 year Treasuries to fall to a four month low of 1.63%.  Since then, we have seen a number of positive economic numbers, including better than expected employment,  retail sales, and durable goods orders.  These numbers, combined with comments from Fed Chairman Bernanke and the release of the Minutes from the May 1st policy meeting has caused the market to rethink how long the Fed will continue its $85 billion a month bond purchase program.  The minutes from the May 1st meeting showed that the committee was much more up-beat on the economy and the labor market than many believed.  The minutes stated “most observed that the outlook for the labor market had shown progress” since the bond buying program began in September.  The minutes, along with a comment on Wednesday from Chairman Bernanke to the Joint Economic Committee that the Fed might start winding down the program within the next few Fed policy meetings, have caused investors to demand higher yields on their bond purchases.  We expect that while economic indicators have been better than expected, the Fed will be very cautious in reducing the level of monetary stimulus.