Treasuries Rally Most Since 2011 as Fed Maintains Buying

Treasuries rallied the most in almost two years after the Federal Reserve unexpectedly maintained the pace of monthly bond purchases that have made the central bank the largest holder of U.S. government debt.

“The Committee decided to await more evidence that progress will be sustained before adjusting the pace of its purchases,” the Federal Open Market Committee said today at the conclusion of a two-day meeting in Washington, referring to its quantitative easing program. Most policy makers expect the first increase in the nation’s benchmark lending rate to occur in 2015 as they seek to use the quantitative-easing strategy to sustain economic growth.

“I’m not sure you can count on the end of QE by mid-next year anymore,” Rick Rieder, BlackRock Inc.’s co-head of fixed income in the Americas, whose New York-based firm is the world’s largest money manager with $3.86 trillion in assets, said during a telephone interview. “The Fed opened the door to keeping QE on the table until the data suggests very much they should start removing it.”

The yield on the benchmark 10-year note fell 16 basis points, or 0.16 percentage point, to 2.69 percent at 4:59 p.m. in New York, according to Bloomberg Bond Trader prices, the biggest drop since Oct. 31, 2011. The price of the 2.5 percent note maturing in August 2023 rose 1 11/32, or, $13.44 per $1,000 face value, to 98 11/32.

Economists had forecast the FOMC would dial down monthly Treasury purchases by $5 billion, to $40 billion, while maintaining its buying of mortgage-backed securities at $40 billion, according to a Bloomberg News survey.

Volume Surges

Treasury trading volume at ICAP Plc, the largest inter-dealer broker of U.S. government debt, rose 52 percent to $457 billion, the most since June 26. The 2013 average is $316.4 billion.

“Once stimulus removal begins, it cannot be quickly reversed, and the Fed is afraid to let the economy try to make it on its own,” Jeffrey Gundlach, manager of the $36 billion DoubleLine Total Return Bond Fund, wrote in an e-mail.

Yields on 10-year notes, the benchmark rate on loans ranging from mortgages to corporate bonds, climbed as high as 3 percent Sept. 5 from 1.93 percent on May 21, the day before Bernanke said that the central bank could slow the pace of Treasury and mortgage bond purchases in the next few policy meetings.

“They don’t want to taper just because they have been talking about it. They want to look at the data and just play it day by day,” said Sean Simko, who oversees $8 billion at SEI Investments Co. in Oaks, Pennsylvania. “This will set the tone of the market for the next couple of weeks, then we’ll wait to see what the minutes say when they are released.”

Funds Forecast

The federal funds rate target will be 2 percent at the end of 2016, according to the median of estimates by five governors on the Fed’s board and 12 reserve bank presidents. That rate compares with their median estimate of 4 percent for where the rate should be at a time of full employment and stable prices.

Twelve of 17 Fed officials see the first rate rise occurring in 2015, and two see it happening in 2016, the forecasts showed. Three officials predicted the first increase in 2014.

In June, 14 fed officials predicted the first rate increase in 2015 and one saw it coming in 2016. The June meeting had two more officials than today’s meeting had.

Today was the first time the FOMC released officials’ 2016 outlook for the funds rate and economic indicators.

Growth Estimates

The fed officials estimated the economy would expand at a 2.5 percent to 3.3 percent rate in 2016, driving unemployment down to 5.4 percent to 5.9 percent with inflation at 1.7 percent to 2 percent, according to their central tendency estimates. The unemployment rate was in line with Fed officials’ longer-run estimate for full employment of 5.2 percent to 5.8 percent.

Gross domestic product will probably grow at a 2 percent annualized pace in the third quarter after expanding at a 2.5 percent rate in the prior three months, according to the median estimate of economists surveyed by Bloomberg Sept. 6-11.

The Fed has kept interest rates at almost zero since December 2008 and undertaken three rounds of bond buying that have swelled its balance sheet to a record of $3.66 trillion. Fed funds futures contract show a 39 percent likelihood that the fed will boost its overnight benchmark rate by at least 25 basis points by December 2014, and a 46.7 percent probability of an increase by January 2015.

‘Dovish Result’

“The Fed took people by surprise by not taking any actions with regard to tapering,” said Gary Pollack, who manages $12 billion as head of fixed-income trading at Deutsche Bank AG’s Private Wealth Management unit in New York. “This is a dovish result.”

Volatility as measured by the Merrill Lynch Option Volatility Estimate Index dropped 9 percent to 82.75, the lowest level since Aug. 14. It has declined from a two-month high of 114.19 on Sept. 5.

Ending the Fed’s third round of quantitative easing carries greater significance than completion of the previous two because QE3 involves open-ended purchases, both in amount and duration, whereas its predecessors were introduced with defined purchase levels over a fixed period of time.

“The market made a big mistake,” said Jim Bianco, president of Bianco Research LLC in Chicago, said in a telephone interview. “Wall Street made the mistake of taking silence from the Fed as approval of tapering, when instead the silence was because of a lack of consensus among the policy makers there.”

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