Fed Policy Surprises Markets

The Federal Reserve surprised financial markets last week by keeping their current pace of asset purchases, known as quantitative easing, in place for the time being.  After hints of a reduction to the size of the program by numerous Fed members over the past few months, market expectations were for the Fed to pull back from $85B in monthly Treasury/Mortgage-Backed Securities purchases to $75B per month.  Citing a weaker than expected economy, labor markets that are improving only slowly, low inflation and a concern over fiscal pressures, the Fed felt it appropriate to keep the amount of bond purchases unchanged.  The “Fed” trade was back after the announcement as most asset classes rose due to the expectation for continued monetary support by the Fed.  The bond market rallied sharply, with yields across the curve declining.  For example, the 10 year Treasury yield fell 16 basis points on Wednesday to 2.69%, one of the biggest one-day rallies in recent memory.  As we have communicated to clients over the past few months, the Fed (and the financial market) is data dependent, and based on recent economic data, a continued rise in rates and substantial selloff in bonds remains unlikely. We will retain this view unless the data (wages, inflation, capacity utilization, capital spending, etc.) begins to turn a corner, which may cause both the Fed and bond investors to reconsider their current stance.