US Treasury debt prices recovered smartly on Wednesday after the Federal Reserve reiterated its commitment to keep interest rates low for an "extended" period, showing no inclination to remove stimulus. That vow quashed speculation that the central bank could use this week's policy meeting to begin laying the groundwork for an eventual tightening of monetary policy, especially given recent improvement in key economic indicators.
In the absence of any such signals, benchmark 10-year notes recouped losses and dashed 9/32 higher in price, pushing yields three basis points lower to 3.42 percent. "People were looking for something a bit more hawkish," said William O'Donnell, head of US Treasury strategy at RBS Securities.
The Fed did acknowledge improvement in the economy, shifting from saying that growth was "levelling out" to stating it had "picked up." However, the optimism was at best cautious. "Economic activity is likely to remain weak for a time," the Fed said. This encouraged bond bulls, who had been worried the central bank might be more specific about outlining some more details of its much-debated stimulus exit strategy. Seven-year notes were up 5/32 and yielding 3.05 percent, down three basis points. The Federal Reserve responded to last year's acute financial crisis by cutting interest rates sharply and flooding the financial system with an unprecedented amount of liquidity, totalling several trillion dollars.
In the process, the central bank more than doubled its credit to the banking system to around $2 trillion, in an effort to revive lending markets that had seized up in the panic that followed the failure of investment firm Lehman Brothers.
These extraordinary measures have sparked some fear of inflation, pushing gold prices near record highs. However, bond investors do not seem to fear a near term spike in consumer prices given relatively low yield levels. Instead, traders seem to agree with the Fed's assessment that, given very weak labour markets, there is still plenty of slack in the economy to prevent undue cost increases.
"I don't think the economy is strong enough for the Fed to start increasing rates or become concerned about inflation," said Alan Lancz, president of Alan B. Lancz & Associates in Toledo, Ohio. But he added that rising commodity prices could become a problem soon enough: "It's going to be a much tougher decision in six months.