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Crescenzi: Scarlett O'Hara on Fed/Inflation Risks

In previewing the FOMC meeting I told investors that an expansion of the Fed's various securities programs was a possibility and that the expansion was likely to be favored over any purchase of Treasuries. This is how events played out, although in hindsight it would have made sense to believe that in order to optimize its securities purchase program that the Fed might want to anchor these securities by purchasing Treasuries—the anchor, and so it did. It is notable that the expansion of the Fed's securities purchase program was far larger than its foray into Treasuries. Again, this is a sign that the Fed wants to continue to emphasize its purchase of securities in the private credit markets most of all, while keeping an eye on the anchor—Treasuries. This theme is likely to be the dominant policy theme for a while, with the Fed staying active in markets vital to unclogging the credit system, and making sure that the anchor stays firmly in place.

As for what constitutes a "long-term" Treasury, take note of Fed Chairman Ben Bernanke's reference to such in his now famous speech on deflation in November 2002 (the New York Fed this afternoon clarified the definition, saying it would focus on maturities between 2 and 10 years):

Bernanke November 2002:

"A more direct method, which I personally prefer, would be for the Fed to begin announcing explicit ceilings for yields on longer-maturity Treasury debt (say, bonds maturing within the next two years)."

"Lower rates over the maturity spectrum of public and private securities should strengthen aggregate demand in the usual ways and thus help to end deflation. Of course, if operating in relatively short-dated Treasury debt proved insufficient, the Fed could also attempt to cap yields of Treasury securities at still longer maturities, say three to six years."

The Fed's announcement has spurred a big decline in mortgage rates of at least 25 basis points. The drop is timely because it ties in well with the Obama administration's Making Home Affordable program, which endeavors to assist up to 9 million homeowners, mostly through mortgage refinancings. Refis, which surged 30% in the latest week, are likely to increase substantially more, with the total amount of refinancings resulting from the MHA program likely to move toward $1 trillion or more over the next few months.

The combination of today's action, the TALF, the PPIF, and government stimulus are likely to make Q1 the trough for the recession.

As for unintended consequences such as inflation, I am sticking with the idea of following Scarlet O'Hara's lead by saying I'll think about that tomorrow.

Betting on these other events are secondary to all other bets that should be placed because of the Fed's actions, chiefly purchasing agencies, agency MBS, and asset-backed securities, as well as other areas supported by the collective balance sheet of the United States, including its own debt, in the 2-10 year sector.

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Tony Crescenzi
Tony Crescenzi

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 author of the forthcoming book, "Investing from the Top Down," "The Strategic Bond Investor," and co-author of the 1200-page book "The Money Market."Crescenzi is a contributor to RealMoney.com."