Fed Comments Should Bolster Bond Market

The Federal Reserve's comments Tuesday substantiate the rebirth or extant momentum in a variety of markets. Topping the list is the run to new contract highs -- and revival of upside momentum -- in June T-bond futures (USM3:CBOT).

In its policy statement issued after meeting this week, the Federal Open Market Committee, said "the probability of an unwelcome substantial fall in inflation exceeds that of a pickup in inflation."

Call it an unwelcome fall in inflation, disinflation or deflation, the comments provide the fuel that should continue to propel the middle and long end of the debt curve, a current that could be discerned in the charts at least a week ago, when T-bonds rallied on bearish news. The Fed's words also support the continuation of the downtrend in dollar index futures (DXM3:NYBOT).

While speculation that the central bank could take the unusual step of buying long-dated Treasury securities, such as 10-year notes, has been around for a while, the Fed's acknowledgement of the risk of deflation enhances the odds it actually will take such action. Becoming a debt buyer -- a move that bids up the price of debt instruments while driving down their yields -- is one of the few remaining weapons in the Fed's policymaking arsenal.

By buying debt, the Fed pays cash or gives credits to banks, increasing the quantity of dollars in circulation. So in a situation of low or no inflation, Fed purchases of debt spur demand for Treasuries, underpinning the uptrend in T-bonds, 10-year notes (TYM3:CBOT), five-year notes (FVM3:CBOT) and T-bills. The resulting rush of cash and reserves into bank vaults increases the supply of dollars and acts as an ongoing weight on greenbacks, driving their price down.

Besides promulgating these trends, the combination of cheaper (lower long-term rates) and more plentiful money provide incentives for consumers and businesses to pay off debt and increase spending, factors that should simulate the economy and stocks.