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Rate Brief

Updated: 2010-09-07, 16:00:14 ET

The Interest Rate Outlook

Surprise. Surprise

The Federal Open Market Committee pulled a few rabbits out of their proverbial hat this week and gave the bond market some new reasons to rally.

Obviously, they did nothing, zip, nada, with rates, this meeting, of course. But The policy-posse ,first off, acknowledged, much as they were expected and pretty much had to, that the pace of the recovery has slowed and will deteriorate at an even "more modest" pace down the road. The crew also said they would keep constant their "holdings of securities at the current level by reinvesting principal payments from agency debt and agency mortgage-backed securities in longer-term Treasury securities. (1) The Committee will continue to roll over the [Fed's] holdings of Treasury securities as they mature." And, of course, they retained the "exceptionally low" for an "extended period" bit just in case anyone thought differently. Boing!

Kansas City Fed President, Tom "Lone Wolf" Hoenig, of course, dissented again.

Bonds were rallying into the statement release, already running at the best levels since April 2009 and added a solid run on the tape-bombs it produced. There was much to digest, but it came down to what many are calling the move just another form of "quantitative easing," or as the clever and cute like to call it "QE2" or "QE the Sequel," or "QE Lite," etc, etc, etc. Anywho, as there had recently been Fed commentary about unwinding some of their market-goosing programs (ahem, Bernanke), many were expecting them to do nothing...although they allowed there was a possibility, wafer thin as it might have been, that they would do something unexpected. Of course, the Fed has a tendency to underperform traders' expectations, this time they decided to play the players, flip it, and really pour on the juice. (Hate the game, not the players.)

They initially said that they would be primarily "concentrated" in the 2-10-year maturity range, which left the 30-year long bond feeling a little left out. But, surprise, when they released their "Tentative Outright Treasury Operation Schedule," lo and behold, they had listings for operations in the February 2011 to May 2040 maturity space for August 26 as well as some 30-year TIPS on the 30 th (they ultimately issued a a correction and pushed out the date August 15 2040, but, whatever).

The market's expectation for the policy crew to start tightening by even the littlest bit has been pushed further out the calendar. Even economists' estimates for hikes have been bumped up with the majority not seeing any move until third quarter 2011. As far as fed funds traders are concerned there is still a chance for further, as in more, "quantitative easing" (in whatever form, to be labeled "QE3," no doubt, when it starts being chattered about ), with players running at about 30% for them to make another such move looking out every meeting to March.

The good news? Rates should remain "exceptionally low" for an "extended period," as long as the "bond vigilantes" stay in their corners with their hands in their pockets, anyway. And the auctions are going pretty, pretty, pretty good, even at these exceptionally low rates. (Hey, thanks for showing up, China!)

Beth Malloy