Fed Leaves "Rates" Unchanged (as expected)

from Mortgage Market Guide

As anticipated, the Fed Announcement yesterday didn't contain any surprises. The Fed Funds Rate was left unchanged - and we don't see that changing until early 2012. Additionally, the language in the Policy Statement was virtually identical to the one following the prior meeting. So what happened? Why did Bonds, which went into the Meeting down sharply, plummet further on the announcement?


Here's the story.
 
Although they are stating that inflation is not a present concern, which is good news for Bonds their continued pledge of economic support prompted Stocks to move higher in response. In fact, the Dow reached levels not seen since Lehman collapsed over two years ago and this all came at great expense to Bonds.


Negative economic news serves to help Bond prices improve and rates decline, including home loan rates and this is all helpful to have when the economy is struggling, as buyers of all products - including homes - need the extra incentive of a low interest rate to be encouraged to buy. But now, the sharply higher expectations for future economic growth has caused rates to climb - particularly including home loan rates, as you well know - and all at a time when the housing market recovery is still on somewhat wobbly legs. This is one of the negative unintended consequences of QE2.


In this morning's news, the Empire State Manufacturing Index was reported at 10.57, far above expectations of 3.0. This was a very nice manufacturing reading, and a whole lot better than what economists were expecting. While this is just one report - it again underscores that the economy is on the mend. The Bond market reacted negatively to this release.

The inflation measuring Consumer Price Index was tame on a month over month basis, showing a climb of 0.1%. With volatile food and energy prices removed, the Core CPI also rose 0.1% for it's first gain since July. The year-over-year headline CPI rose 1.1% - still below the Fed's target - but it is worth noting that this is the fifth consecutive month of increases in the headline CPI number. For now - deflation fears have left the building, and the Fed appears to be on track with their goal of stimulating a bit more inflation.

Where will rates go from here?

In the short-run, the Bond is attempting to hold at support at $98.03 - and only time will tell if that floor will hold. But there is an extremely negative sentiment towards Bonds right now. Look no further than the major outflows being seen from Bond mutual funds. The amount of money leaving the Bond market over the past two months is the most in a few years and what this means is that investors are not only not adding to their Bond positions but they are also selling off current holdings. This is another reason why the selloff in Bonds has been so significant over the past several weeks.