What The FOMC Statement Means For Your Bond Portfolio

The Federal Reserve Open Market Committee (FOMC) continued tapering purchases of mortgage-backed securities and left forward guidance largely unchanged from previous meetings.

Waiting On Data

Janet Yellen, chair of the Federal Reserve, maintained that the Fed's decision as to when to raise rates is still data dependent. She emphasized that the gap between current employment and the Fed's desired level of full employment is shrinking.

The same is true for the Fed's desired inflation target of 2 percent. Year-over-year inflation is beneath that rate, up only 1.7 percent as measured by the CPI. Yellen emphasized that as long as both unemployment and inflation remain below the Fed's targets, interest rates will remain low for a “considerable period.” In other words the end of QE3 in October does not signal an imminent change in Fed policy toward higher rates.

Rate Expectations

Both Federal Reserve officials and market participants expect rates to rise in the second half of 2015, possibly as early as June. This forecast of the timing of the first rate rise is unchanged from the last meeting. Chairwoman Yellen confirmed this and reiterated that economic conditions are largely the same as in June.

Related Link: FOMC Statement From September 16-17 Meeting

Unemployment 

The Fed would like the unemployment rate to be lower. Yellen specifically pointed to the need for the Fed to see more individuals reenter the workforce before declaring the labor market fully healed from the 2008 recession. The labor participation rate now stands at 62.8 percent, a historic low. This signals that the domestic labor pool is shrinking, as many potential workers are too discouraged by the job market to even seek employment.

The participation rate is a key component in on Yellen's “dashboard” of economic indicators. Her mentioning of it in today's press conference signals to the market that the Fed is not only measuring how many jobs were created each month, but also the size of the total labor pool. Until more unemployed reenter the labor pool, regardless of whether they find a job, the Fed will not raise rates.

Market Reaction

The market took Wednesday's policy decision as less hawkish than expected. The retention of the phrase “considerable period” eased concerns that rates would be rising soon. The Treasury market yield curve flattened with short-term rates rising more than long-term rates.

The 10-year note closed at 2.59 percent, below its breakout range of 2.65 percent last spring. With the Fed on hold and economic conditions unchanged, expect the 10-year note to trade between 2.65 percent and 2.45 percent over the next few months.

Equities held on to their gains of yesterday as investors cheered the continuing of the accommodative policy of the Fed. The firmness of the dollar also attracted overseas investors back into stocks and long-term Treasuries.