Fed Actions: What Does it all Mean?

The Federal Reserve met on Tuesday, March 16th and published their rate-setting statement. What does it mean? How did the financial markets react? What can be learned from their statements and actions?

Short term interest rates: The Fed continued their policy statement that they will keep short term interest rates at "exceptionally low levels...for an extended period" of time. Note that in Fed speak, an extended period of time is interpreted as a number of months (some analysts think 6-9 months), not necessarily years, as one would generally think. Thus, short term rates will remain very low, in the near term.

Mortgage rates: The Fed, as expected, is nearing the completion of the emergency measures they undertook in 2008 and 2009, to purchase various mortgage securities and securities of housing related government "agency bonds." The purpose of these actions was to keep interest rates low on mortgages, to make mortgages and housing more affordable.

It is interesting to observe, as I have written about before, how difficult it is to predict the financial markets. It has been widely anticipated that the Fed would be stopping these purchases, which would cause mortgage rates to rise in 2010. So what has happened? Just the opposite, so far. Rates on 30 year mortgages have fallen from 5.28% in early January to a current rate of around 5.05%. Evidence again that the financial markets cannot be accurately predicted in advance.

Inflation: The Fed expects "inflation is likely to be subdued for some time," as they feel that there is still significant under utilization of resources and capacity, and that will keep cost pressures down. They also feel that long term inflation expectations are stable.

As advisors managing fixed income portfolios, we do not make predictions about the direction of interest rates. As noted above, to attempt to do that is nearly impossible, particularly over a long period of time. We would prefer to build a diversified portfolio of very high quality fixed income securities, of varying maturities, so that we will get the interest rate return of the market, and not risk losing money by betting on the direction interest rate moves.