Some notes on the Federal Reserve's situation as we look forward to its decision today ...

* The fed funds futures market is priced for the Fed to deliver its first rate hike by the September 16th FOMC meeting, which explains why the 2-year note has been trading close to a percentage point over the funds rate, since 2s tend to trade at such a wide spread when a hike is around the bend.

Tony Crescenzi
Senior VP,
Strategist,
Portfolio Manager
Pimco

* I personally have not agreed with the expectation, since I believe that the Fed's concerns about the financial system and economic risks outweigh its concerns about inflation risks. This is why I have said that the recent rate rise has been excessive.

* Nevertheless, I do agree with the idea that rate increases are more likely than rate cuts, leaving little room for a rally in Treasury prices. In other words, while yields are not likely to climb much in the near-term, they probably won't fall much either.

* Through it all, the general thrust in rates is therefore likely to be up from here and this will be especially true when the 2009 economic recovery rolls around.

* Keep in mind that today's 2% funds rate is not the same as in past years in terms of its impact on credit formation. Many rates are tied to the funds rate, but they have not fallen as much as the funds rate. LIBOR is the most obvious in this regard. Other credit spreads remain wide -- corporate bond yields, for example.

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* The Fed has emphasized in recent weeks the importance of anchoring inflation expectations. Fed Chairman Ben Bernanke said on June 9th that "the latest round of increases in energy prices has added to the upside risks to inflation and inflation expectations. The Federal Open Market Committee will strongly resist an erosion of longer-term inflation expectations." His "strongly resist" remark received a great deal of attention in the financial markets, as it hinted at the possibility that the Fed would raise interest rates if inflation expectations were to rise. Additional emphasis on inflation expectations is likely in today's statement.

* The Fed will likely continue, as it did in April, to refer back to its past actions as a way of saying, "Here's what we've done; it's enough for now, let's see how the actions play out."

* There were two dissents last time around. The dissenters, Plosser and Fisher, wanted the Fed to stand pat in April instead of cutting rates as it did. The dissenters will hence be pleased with the pause and it is unlikely that any members will dissent today, because if they did they would be doing so most like in favor of a hike (not a cut).

More: Click for Latest Economic coverage ...

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Tony Crescenzi is the Chief Bond Market Strategist at Miller Tabak + Co., LLC where he advises many of the nation's top institutional investors on issues related to the bond market, the economy and other macro-related issues. Crescenzi makes regular appearances on financial television stations such as CNBC and Bloomberg, and is frequently quoted across the news media. He is also the co-author of the just-revised "The Money Market" and "The Strategic Bond Investor."

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