An Excerpt from CRB'S Futures Market Service.

Fed’s extension of low rates at least until late-2014 raises risks for overkill and inflation

The FOMC at its meeting earlier this week extended its outlook for “exceptionally low” rates by another 1-1/2 years until late-2014 from its previous timeframe of mid-2013.  Fed Chairman Bernanke also said that another bond buying program (QE3) is “an option that’s certainly on the table.”

Our take on the Fed’s decision is that the Fed is now going farther than it needs to in order to support the economic expansion and consumer/business confidence.  It can be argued that the Fed this week actually did not do anything because it left its federal funds rate target and its asset purchase programs and targets unchanged.  The Fed didn’t actually announce QE3 and the Fed’s language on low rates until late-2014 is only a forecast and is not an actual promise.  The Fed could still quickly change its mind and retract that late-2014 language at any time.

In a sense, the Fed’s decision is smart because the Fed didn’t actually make a policy change and is simply playing with market expectations.  Nevertheless, the Fed’s decision to become even more dovish in its policy outlook matters, particularly when it comes to inflation expectations.  In fact, the 30-year breakeven inflation expectations rate after the meeting rose by 7 bp to 2.34% from 2.27%.  Moreover, gold rallied by $55 per ounce in 2 days and the dollar index posted a new 6-week low. 

With the U.S. economy improving and with the European debt crisis stabilized for the time being (unless a Greek deal fails), the Fed was not under the gun to turn more dovish and could have simply let things stand with some vague hints of QE3.  Instead, the Fed went out of its way to present an even more dovish stance.  That stance in our view is starting to look panicky and excessively dovish.  The Fed’s move this week will make bond investors even more worried about whether the Fed is going to drive an easy monetary policy off the cliff and fail to recognize when it is time to raise rates.  We continue to suspect that there is eventually going to be a big upward spike in long-term yields when it becomes clear that the Fed has gone too far and can’t retract its monetary policy in time to prevent an inflation burst.  That spike may be more than a year down the road, but we still suspect that it will be coming.
 

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