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Rates Jump After FOMC Announcement

As expected, the Fed continued on its path of $10B/month tapering, continuing to ease off the gas pedal of accommodation. Additionally, it finally dropped the reference to 6.5% unemployment rate threshold for a tightening cycle (someone call the BLS and let them know they can report 6.4% UR in two weeks). In general, the tone was bullish on the economy and has caused rates to jump.

Highlights:

– “Labor market indicators were mixed but on balance showed further improvement.”
– “The Committee sees the risks to the outlook for the economy and the labor market as nearly balanced.”
– “The Committee recognizes that inflation persistently below its two percent objective could pose risks to economic performance, and it is monitoring inflation developments carefully for evidence that inflation will move back toward its objective over the medium term.”
– “In determining how long to maintain the current 0-.25% percent target range for the federal funds rate, the Committee will assess progress – both realized and expected – toward its objectives of maximum employment and two percent inflation.”
– “This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments.” (dropped the 6.5% threshold)
– “The Committee continues to anticipate…that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends…” (in other words, tapering does not equal tightening)
– “The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.”

The last bullet point is one we have been suggesting for several months. In December, staff economists released a paper suggesting the Fed keep Fed Funds (and therefore LIBOR) low well beyond a full recovery in the labor markets. We continue to believe this opens the door to LIBOR low beyond mid-2015.

But the markets and several Fed members disagree. Thirteen Fed members forecast the first hike to come in 2015 and more members see Fed Funds at least 1.00% by the end of 2015. Front end fixed rates are up more on a relative basis than long end rates like the 10yr Treasury, but 5 year rates are getting hammered the most.

This is because 2 year Treasurys are still within the timeframe of the Fed’s commitment to ZIRP, so they can’t jump too dramatically. The 10yr Treasury is less affected by Fed Funds, so it too is up but not as much as the five year. But the 5 year is stuck in limbo – far enough out that the Fed could be well into a tightening cycle in a few years, but not completely disconnected like the 10 and 30 year rates.

2 year Treasurys are up 0.07%
5 year Treasurys are up 0.13%
10 year Treasurys are up 0.09%

Yellen Q&A occurring now, will keep everyone posted with updates as warranted.

Click to Open: FOMC Word for Word Changes

FOMC Word for Word Changes 3.19.14