Following the Federal Open Market Committee on 23 and 24 June, and to no great surprise, the US central bank left its key rates unchanged (at between 0% and 0.25% for Fed Funds and 0.5% for the discount rate). It also confirmed the planned purchase of securities: $1,250bn of agency MBS and $200bn of agency debt securities by the end of the year plus $300bn in treasury note by the autumn. The Fed also slightly modified its statement from the April edition, removing a sentence from the paragraph on prices: “Moreover, the Committee sees some risk that inflation could persist for a time below rates that best foster economic growth and price stability in the longer term.” This alteration suggests that the Fed is less worried by the risk of inflation than it has been in the recent past, but not yet particularly worried about a rapid surge in inflation, which “will remain subdued for some time.” The financial markets seemed to be disappointed that the Fed did not set out the length of time over which it expects to maintain the status quo in monetary policy, merely repeating that “economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period”. Nor did the Central Bank seem unduly concerned about the recent rise in long-term government bond yields. Rather, the Fed seemed to see it as a reflection of improved expectations of economic recovery. Indeed, as far as economic activity is concerned, the Fed underlined that the data and survey findings published since the FOMC meeting on 28 and 29 April suggest that the pace of economic contraction is slowing. This week, publication of durable goods order numbers showed a 1.8% rise in May, as in April, signalling a nascent recovery in the sector. Orders have increased significantly over the past two months, whilst inventories have steadily fallen since the beginning of the year. This positive trend is in line with survey data from the manufacturing sector, in particular with the ISM survey, whose new orders component rose above 50 in May for the firs time since the end of 2007. Despite this, the next few weeks are likely to be positive for the bond market as equity markets catch their breath now that the bulk of the pleasant surprises seem to be discounted in share prices.
In the euro zone, the first one-year loan operation launched on Wednesday 24 June by the ECB proved a huge success. A total of 1,121 establishments made use of the facility for a total amount of €442.24bn borrowed at the refinancing rate. The greater than expected success of this operation (the Central Bank had previously limited refinancing operations to 6 months) triggered a rally at the short end of the bond yield curve. German and French 2-year rates fell by 7 basis points to 1.40% and 1.64% respectively. The Eonia rate, which had risen sharply on the eve of the operation (from 0.75% to 1.38%), thus interrupting five consecutive weeks of falls, eased back again once the operation was complete. The success of this operation was probably linked to current borrowing conditions which are considered as extremely favourable. The next two operations of this type will take place on 29 September and 15 December. The ECB might then allocate funds at the refi rate plus a premium. This will probably not prevent financial institutions from tendering in a large way at the end of the year, given the liquidity visibility it would provide. This massive injection of liquidity (the largest previous programme of this sort, in December 2007, totalled €348.6bn) should allow the region's banks to support the economic recovery now beginning to take shape. PMI surveys for June confirmed a gradual emergence from recession. The composite activity index, traditionally a good advance indicator of GDP growth, rose slightly. At 44.4 it was 6 points higher than in the first quarter and more than 8 points above the low recorded in February. However, it still suggests a further contraction of the economy, albeit on a more modest scale than in Q1 2009.
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