On the home front, the Federal Reserve took some uncertainty out of the market earlier in 2011 when it gave some clarity to what it meant by "exceptionally low rates for an extended period of time." The Fed basically vowed to keep its Fed Funds rate at the current 0-0.25% through mid-2013.
Larry McDonald, senior director of credit sales and trading at Newedge, is confident the Fed will stand by this projection. "This new language the Fed is using in terms of visibility is a new tool and they don’t want to hurt the integrity of that tool. When you say to Wall Street that you’re going to keep rates at a certain point, if you hold to your word, then it creates a new tool of liquidity," he says.
While many in the financial world worry about potential inflation from this long-term accommodative stance, the Fed appears to be focused on the "full employment" part of its dual mandate. And employment remains at crisis levels while inflation expectations have leveled off.
Nonfarm payrolls have continued to grow modestly in the second half of 2011. In the November report, released on Dec. 2, the U.S. economy added 120,000 jobs and unemployment had ticked down to 8.6%, a decrease of 0.4% from the previous month. The surprisingly large drop in the rate did not match the more modest jobs numbers and most likely is because of long-time unemployed falling out of the survey.
Dave Toth, director of technical research at R.J. O’Brien’s Market Research & Trading, says employment is at the heart of the crisis. "You can pump as much money into the system as you want, but if people aren’t out there buying and chasing goods because they don’t have jobs or they have to worry about their jobs, then there’s not going to be any sustained upward pressure on rates, stock prices or economic growth," he says.
Rodock says the United States won’t see sustained recovery until the labor situation turns around. "The Fed realizes we’re not seeing a lot of demand for borrowing because of [high unemployment]. People who don’t have jobs aren’t going to take out a loan for a new mortgage or car, they’re going to pile their money into cash and save it," he says. "If we start getting jobs back, liquidity start to free itself up and more people are willing to borrow. That itself will get the market chugging along." At this point, though, Rodock believes the Fed is doing everything in its power to stimulate jobs growth.
Although a number of fears last year surrounded a double-dip recession and the possibility that the United States may enter a period of deflation, that never materialized as the Fed finished QE2 and implemented "Operation Twist," in which it currently is selling short-dated securities to purchase ones further out in the curve.
Looking to 2012, most analysts don’t expect inflation to pick up much. "We’re not looking for a big pick-up in inflation, in fact it may drift a little lower from here," Jones says. "We’ve seen quite a few things come off their highs."
Based on those inflation expectations, Jones is expecting 10-year notes and 30-year bonds to remain in a trading range through the first part of 2012. Although she doesn’t forecast prices, she says the 10-year T-note yield will stay around 2%, plus or minus 20 basis points. The 30-year T-bond will stay in the 3% to 3.4% range.