Fed Leaves Fund Rates Steady At Two, Treasury Dips

Following the Federal Reserve’s decision to keep the federal fund rates steady at 2%, the government bond prices saw a slight fall on Tuesday, despite the fact that it was an expected move.

The Fed had been cutting interest rates since September last year. In total the rates had been cut seven times since September ’07 to April ’08, owing to economic slowdown. However, as expected by traders this announcement came without any further cuts, in order to maintain the balance between economic slowdown and inflation.

"Although downside risks to growth remain, the upside risks to inflation are also of significant concern to the Committee," the Fed said in its statement.

Although the fall was a slight one, it was also influenced by the news of the auction of government debt worth $27 billion towards this week end. The U.S. Treasury Department is expected to auction $17 billion in new 10-year notes and $10 billion in new 30-year bonds this week.

As a result, the benchmark 10-year note fell 11/32 to 98 31/32 and its yield rose to 4%. The 2-year note fell 1/32 to 100 12/32 and yielded 2.54%. The 30-year long bond fell 28/32 to 96 2/32, with the yield rising to 4.62%. Bond prices and yields move in opposite directions.

"Basically, it is a slight dip," said William Larkin, portfolio manager at Cabot Money Management, "which to me is almost no change."

Despite its concerns over inflation the Fed decided to keep the rates steady as of now and did not increase them. "They did what they were supposed to do," said Larkin. "They addressed everybody's concerns."

He, however, also added that "It is a slight negative that they are not tightening the screws, because when the economy does get traction, there is now a growing possibility it might be more difficult to control the future inflation,"

Larkin’s concerns focus mainly on the Bond investors who according to him benefit if the inflation is kept under control. The rise in inflation decreases the value of their long term investments. He therefore hopes that the fed has done the right thing in keeping the rates steady assuming a fall in inflation.

"If their assumptions are wrong, bond investors will get hurt the worst because the principle erosion could get worse," said Larkin.

Many analysts are expecting certain policy changes from the fed in order to boost the economy as the year progresses. This is expected to offer relief from the rising inflation thus benefiting the bond investors.

"The Fed's actions are going to continue to come though tweaking the market support programs and not changing the interest rates," said Steve Van Order, fixed-income strategist at Calvert Funds, in a conversation before the Fed's decision was announced.

"We are in a cycle of heavy Treasury supply because of all the things that have to be financed," said Van Order. “Federal debt as a percentage of gross domestic product is climbing, which means investors can expect more government bonds to be sold,” he added.

Analysts are expecting the debt auctions to make the next difference in the economy now. “There is a lot of new supply coming," said Van Order. "If the auctions are sloppy, then there might be a big sell off. If the auctions go well, we could have a little rally."