THE BASIS POINT

Why Rates Didn’t Drop On Today’s Fed Announcement. Hoenig Dissents On Low Rate Vote 5th Time.

Mortgage bonds closed up 19 basis points today following a Fed meeting where they kept their low rate stance. Mortgage lender rate sheets didn’t decrease commensurately as lenders held the line ahead of a 10yr Treasury note auction Wednesday and a 30yr T-Bond auction Thursday. Lenders do this because longer-dated Treasury auctions compete with mortgage bonds for buying attention, and can cause mortgage bonds to sell off which pushes rates higher. More on today’s FOMC meeting below.

The Federal Open Market Committee voted to keep the overnight bank-to-bank Fed Funds Rate steady at 0-0.25% and the overnight Fed-to-bank discount rate at .75%, citing subdued inflation that’s likely to continue for “some time.” For the fifth straight meeting in 2010, Kansas City Fed President Thomas Hoenig dissented on the belief that modest rate hikes now (in the form of overnight rate hikes and/or Fed selling of their massive mortgage bond portfolio) could avoid having to sharply increase rates later. The FOMC also said it wouldn’t start selling the $1.25t of mortgage bonds they purchased from January 2009 to March 2010, and they’d reinvest principal payments received on these holdings into Treasury securities—not selling mortgage bonds and buying more Treasuries with profits keeps yields (or rates) on mortgages and Treasuries low.

FULL FED STATEMENT
Information received since the Federal Open Market Committee met in June indicates that the pace of recovery in output and employment has slowed in recent months. Household spending is increasing gradually, but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software is rising; however, investment in nonresidential structures continues to be weak and employers remain reluctant to add to payrolls. Housing starts remain at a depressed level. Bank lending has continued to contract. Nonetheless, the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, although the pace of economic recovery is likely to be more modest in the near term than had been anticipated.

Measures of underlying inflation have trended lower in recent quarters and, with substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to be subdued for some time.

The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period.

To help support the economic recovery in a context of price stability, the Committee will keep constant the Federal Reserve’s holdings of securities at their current level by reinvesting principal payments from agency debt and agency mortgage-backed securities in longer-term Treasury securities. The Committee will continue to roll over the Federal Reserve’s holdings of Treasury securities as they mature.

The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to promote economic recovery and price stability.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; James Bullard; Elizabeth A. Duke; Donald L. Kohn; Sandra Pianalto; Eric S. Rosengren; Daniel K. Tarullo; and Kevin M. Warsh.

Voting against the policy was Thomas M. Hoenig, who judges that the economy is recovering modestly, as projected. Accordingly, he believed that continuing to express the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted and limits the Committee’s ability to adjust policy when needed. In addition, given economic and financial conditions, Mr. Hoenig did not believe that keeping constant the size of the Federal Reserve’s holdings of longer-term securities at their current level was required to support a return to the Committee’s policy objectives.