Bond Expert Friday Outlook

by: John Jansen

Prices of Treasury coupon securities are posting some modest losses in overnight trading in response to an FT article which muses on the possibility that the Federal Reserve might change the “extended period ” language as policy evolves in preparation for the end of the emergency measures which have taken rates to zero.

I have long argued that the Federal Reserve will not raise rates as long as the labor market is weak. And weak it remains with the unemployment rate at 9.8 percent and rising. The most recent set of FOMC minutes which cover the deliberations at the last conclave of this august council dwell on the concerns of the Committee members about the labor market and the risks which a weak labor market poses for the recovery.

So with the rate rising and with businesses still shedding jobs and with the weekly initial claims data posting in the mid 500s, I do not see a case in which the FOMC would opt to raise rates sooner rather than later.

I would offer another point that there is an element of politics at work here also.

Next year is an election year in the US. The current Administration and (more so) the current Congress would relish the opportunity to run against the Federal Reserve in the off year election. If the unemployment rate is at or near double digit levels, any move to raise rates would bring forth Barney Frank and those of his ilk with a 21st century version of the William Jennings Bryan “Cross of Gold” speech. It would give the faux populists of our time an opportunity to attack the Federal Reserve and a golden opportunity to challenge the independence of the Federal Reserve and suggest more political involvement in the setting of interest rate policy.

I think the calls from that quarter would be legion as politicians seek to deflect the public from a discussion of the profligate spending which truly threatens the recovery and a viable future.

I do not believe the Federal Reserve wishes to be the whipping boy and the scapegoat of the 2010 off year election and unless the labor market has manifested improvement, the Federal Reserve will literally interpret the “extended period” mantra it has been chanting for much of this year.

In addition, the article in the FT lacks a direct quote regarding a change of language. I do not expect that newspaper to print a name, but there should be some quotation marks around something an anonymous official(s) said. I do not see that in the article.

The front end has suffered the slings and arrows of outrageous fortune in response to this article, which suggests some small steps on the road to higher short rates, and the curve is flatter overnight.

The yield ont the 3 year note has increased 4 basis points to 1.53 percent. The yield on the 5 year note has climbed 4 basis points to 2.40 percent. The yield on the 7 year note increased 4 basis points and rests at 3.06 percent. The yield on the 10 year note has edged higher by 3 basis points and rests at 3.44 percent. And the still investment grade Long Bond has seen its yield jump 3 basis points to 4.26 percent.

The 2 year/10 year spread is 246 basis points.

The 10 year/30 year spread is 82 basis points.

The belly of the curve has a little bit of financial dyspepsia as the supply in that sector has cheapened the 2 year/5 year/30 year spread to 44 basis points.