To no one's surprise, the Federal Open Market Committee (FOMC) voted to leave its federal funds rate target unchanged at 1.25 percent and maintain its neutral stance. The official statement below succinctly describes the feeling at the Fed:

The latest inflation figure shows that the PCE deflator was up 2.1 percent in October versus a year earlier. With the federal funds rate target at 1.25 percent, the real (inflation-adjusted) fed funds rate remains firmly in negative territory. Fed officials said their policy was stimulative even before they reduced the funds rate target last month - there is no doubt that a deeper negative real fed funds rate is even more stimulative.

Treasury Market
What has happened to interest rates since the Fed reduced its funds rate target last month to its lowest level since 1961? Based on the chart below, it doesn't appear that yields have done a thing! In fact, the yield on the 30-year Treasury bond edged down 16 basis points. The yield on the 10-year note is down 2 basis points from the level it was before the Fed rate cut. Yields on shorter term securities are actually higher than they were before the cut! The 5-year Treasury note yield is 12 basis points higher and the 2-year note yield is 7 basis points higher than the day before the Fed's rate cut to 1.25 percent.

Yields have certainly fluctuated sharply in the past five weeks, and on some days they have been lower than on November 5th, the day before the Fed's action. But for the most part, daily yields have generally been higher; the yields on December 10th are certainly reflective of the norm.

Why is it so important that the impact of the Fed's rate cut is felt in the Treasury market? Treasury yields are used as benchmarks for a wide variety of other interest rate instruments. In particular, fixed rate mortgages are tied to the 10-year Treasury note.

Mortgage Market
The average mortgage rate fell to 6.07 percent in November, down from 6.11 in October and 6.09 in September. That could hardly be called a decisive change in mortgage rates. The chart below depicts the average weekly rates in the week before the Fed rate cut and five weeks later (the latest data available, for the week ended Dec. 6). Note that one can hardly discern a difference. In fact, the 30-year and 15-year fixed mortgage rates were higher in the latest week than five weeks ago. The 1-year ARM was 4 basis points lower.

If the Fed was counting on the housing market to help jump-start the economy at this point, it isn't likely to happen. Some consumers are certainly benefiting from low mortgage rates. The overall low level of rates has allowed many more homeowners to refinance their homes. At this point, the economy also needs to see more improvement in employment and earnings. Consumers who are worried about their job status are not likely to rush out and buy a home - even with the low mortgage rate.

BOTTOM LINE
The Fed has done its part in easing monetary policy over the past couple of years. The federal funds rate target stands at its lowest level since early 1961. Despite the Fed's accommodative monetary policy, bond investors have not allowed Treasury yields to decline in tandem with the fed funds rate. Certainly, the Treasury securities market is affected by factors other than just monetary policy since it is also considered a safe-haven investment. Lately, bond investors are also starting to worry that a burgeoning budget deficit will lead to increased borrowing from the Federal government and an increased supply of Treasury securities. That would lead to higher interest rates.

In the meantime, however, the economy is soggy and the Fed is not likely to raise rates any time soon. The low interest rate environment is secure for now. That would imply that bond investors might be overly cautious as to the direction of future rates. If Treasury yields continue to drift higher, it is likely that mortgage rates will drift higher as well, and one of the main conduits of monetary policy will not be allowed to work its trickle down magic.

Evelina M. Tainer, Chief Economist, Econoday