The FOMC Statement: The Day After

The FOMC's unambiguously bond market-friendly statement yesterday provided a strong boost to Treasuries, triggering a rally that has brought the 10-year yield within striking distance of the 3% mark.

In surveying the landscape today, a few comments are in order:

1) The subtle, but unmistakable, caution reflected in the Committee's assessment of the growth prospects, pushes the possible timing of the first tightening move well into 2011 (with a more specific handle on such timing being hard to assess at this distance). This is strongly reinforced by the acknowledgement in the Committee's statement that, in addition to financial market conditions that are not "supportive" of growth", inflation is also trending lower. It is critical to stress here that an outright Fed tightening move does not necessarily have to coincide with the beginning of any asset sales from the Fed's portfolio, as the latter might come first- although it has now also been pushed further out. (We will have a special article on the various pieces of the Fed's exit strategy in the coming days).

2) While fed funds futures moved quickly to remove the bulk of any risk for a Fed move this year (with only a "natural" residual of risk left in the pricing of the December contract due to ever-present, background concern about year-end distortions in the funds market), Eurodollar futures continue to reflect a moderate, steady uptrend in the 3-month LIBOR rate- the direct effect of ongoing concerns about bank liquidity. Such concerns are also fueled by the prospect of the release of the bank stress-test results in Europe at some point next month.

3) With the Treasury yield curve on course to maintain its core steepness for quite some time now, plain, old-fashioned carry trades remain very much in vogue. Viewed from a slightly different angle, this implies that any curve flattening trades, which may still have some appeal in the midst of a potential stretch of strong economic reports, should be managed with caution and viewed as purely tactical and with limited objectives.

Anthony Karydakis