The Fed Leaves Interest Rate Policy Unchanged
Today the Fed reaffirmed their view that the economy is not growing fast enough to adequately battle unemployment; they therefore left their interest rate policy unchanged. For now the Fed will continue to pump money into the bond market.
Bond Prices are Weaker
Despite the Fed's actions to keep bond prices up and interest rates down, market factors have caused a mild correction in bond prices lately. This hardly signals a bursting of the so-called "bond bubble."
Why are bond prices weaker?
Rates are moving up simply because it appears that our economy will perform a little better in 2011 than forecasters expected just a couple of months ago. It does not mean that housing will get much better or that the unemployment rate will fall drastically, but it does mean that demand for consumer goods are slightly firmer and that is good for the economy. A couple of months ago it appeared that the economy was headed into a double-dip recession, but for now that fear has subsided. We appear on track for subdued growth next year.
Another factor impacting bond prices was disappointment about the size of the Fed's latest bailout program (QE2). QE2 is a bond-buying program designed by the Fed to keep bond prices up and interest rates down, but the amount (at just $600 billion) was below expectations and that caused a mild sell-off in bonds. What is clear now is that this created a "buy-the-rumor, sell-the-news" event in the market.
Another factor helping the economic outlook is the surprising tax compromise working its way through Washington. The bond market does not like surprises and this surprise came last week which was auction week for Treasuries. Treasury prices usually weaken during auction week, but news of a tax compromise in Washington caused more short-term bond investors to dash to the sidelines.
Looking Ahead
While interest rates have backed up a bit, they are only back to the levels they were at this spring so the correction is not large. Yes it is something worth noting but we have to also remember that two very significant economic factors favor the outlook for bonds. First is the European financial crisis which is far from over. Much still has to be done to contain the sovereign debt problems plaguing Europe and all of these factors make our bonds look relatively attractive. Second, our economy simply is not that strong. The Fed is committed to printing money to buy Treasuries, and that is good for the bond market.
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