Today - Pre FOMC

The market is a bit confused this morning as it continues to digest some conflicting information. The Organization for Economic Cooperation and Development (OECD) revised upwards its previous forecast for the combined GDP of its member states. The previous forecast made in March was for contractions of 4.3% in 2009 and .1% in 2010, both revised up today to -4.1% and +.7% respectively. This comes just one day after The World Bank revised their forecast for global GDP downward to -2.9% in 2009, from -1.7% in March. The scale of these predictions is obviously way too large to be accurate, but I just use it as an example of the contradicting information the market is dealing with in this environment.

Which brings us to what lies ahead for today. A strong Durable Goods number lead by better than expected increases in new orders for machinery and capital goods (up 7.7% and 9.5% MoM respectively) is helping futures higher pre-market, but most of the market is carefully awaiting the statement from the Federal Open Market Committee (FOMC) that is expected to maintain a 0-.25% target for Fed-Funds (the rate used for overnight lending between banks).

The real question lies in what kind of guidance they choose to give on their open market operations, namely their large scale quantitative easing campaign that they injected with steroids in March. The numbers are already huge, ($1.25 trillion in agency MBS, $300 billion in Treasuries and $200 billion in agency debentures) but some think that increasing them is not completely out of the question. Consider the effects that would have on the market. The market is forward looking, not always 20/20 but undoubtedly concerned about the future. Let say the Fed triples their Treasury purchases to $1 trillion in an attempt to lower long term rates to help worthy corporate borrowers who would benefit from lower long term rate to finance expansion. There are two quick problems with that scenario. First, the market has chilled out considerably on the inflation front in the past 3 weeks or so, but boosting quantitative easing will only renew those fears in my opinion, and along with increased inflation concerns comes higher long term rates. Result… the Fed fails to manage the long end of the curve and has only succeded in funding our Nation’s irresponsible deficit. Second, rates are already very low, sure they have run up since the beginning of this year, but mortgages are at 5.5% and a company who is rated one notch above junk can borrow for 10 years at roughly 7.5%. (HT Brent Vondera) That is far from a contractionary interest rate environment. The Fed has eased enough here in my view.

Instead of increasing the size of the total purchases, I believe the Fed if anything is more likely to slice up the pieces a little differently. Take some money away from MBS and put it towards Treasuries, and concentrate on moving the risk free curve instead of individual markets. That’s my prediction, now we just sit and wait for 2:15 ET.

Cliff J. Reynolds Jr., Junior Analyst