Just as we mentioned in yesterday's Daily Update, we knew the Fed would not make any changes to the Fed Funds Rate following yesterday's meeting - and sure enough, the Fed voted to leave monetary policy "as is", with the Fed Funds Rate held steady at 5.25%.
However, it was the tone of the Policy Statement that was in question...and indeed, although the statement was short, it was not so sweet for Bonds, which declined a bit following the release. Why? Because the market was looking for a little love from the Fed, particularly in regards to inflation. Recent inflation and wage data has all been friendly, and the economy is slowing a bit as well. So, the markets were expecting some sweet talk from the Fed about inflation being under control...but instead, the Fed said their predominant concern is that inflation will "fail to moderate as expected". While we know the Fed's primary mission is to be on guard against inflation, the market was hoping for a little kinder tone and encouragement on this front, and was a bit displeased with the tone of the Statement.
This morning, Initial Jobless Claims showed continued signs of a tight labor market as Claims were reported at 297,000, lower than expectations of 315,000 and their lowest level since the middle of January. Additionally, the Balance of Trade Report showed our trade deficit increased by 10.4% in March to $63.9 Billion, much higher than expectations of $59.6B and the widest trade gap since September 2005. Our trade deficit with China continues to grow, now with a $17.2B deficit compared with a $15.6B deficit for the same month last year. Bonds had little reaction to these reports.
But here's a story to watch from "across the pond" - the Bank of England announced a hike in their official interest rates by a .25% to 5.5%, their highest level in six years. Just like our Fed works to control inflation in the US, the Bank of England is attacking their inflation which recently hit an annual rate of 3.1%. The Bank of England has a desired inflation target rate of 2.0%, and until their inflation gets under control, they will likely continue to hike. How does this impact us? When yields start to move higher in other countries, it makes our US Bonds less attractive to foreign investors and central banks, who have been a major buyer of our Bonds. High demand for our Bonds kept prices high and interest rates low. But global investors will seek the highest yields available, and if Great Britain is now offering a primary yield that is .25% higher than our Fed Funds Rate, some of the foreign capital may start to be invested there, rather than in US Bonds. And if foreigners start buying less of our US Bonds, Bond prices will naturally decline as the demand slows. This in turn means that home loan rates could drift higher over time, if foreign buying declines significantly.
Bonds are currently at +3 basis points so we don't anticipate any intraday rate changes. However, in reactioin to yesterday's news, rates did increased an 1/8 (.125).
Also in the news in Britain, Prime Minister Tony Blair announced his resignation after ten years in office, saying "That's long enough for me."
Have a GREAT day!
~Santos
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