Don't Trample The Green Shoots

So the Fed held fire on expanding the Treasury purchase program Wednesday - but there's one thing one shouldn't overlook: the program runs until the fall - ie September. So either at the June or the August FOMC, it'll have to make the decision whether to expand its buying.

In the meantime, there's plenty of bad news lurking that could prevent a full-blown, sustained sell-off in the long end of the Treasury market - even though the 10-year yield could well test the 3.25% mark before all is said and done. Right now, the market is obsessing with supply - no wonder, Treasury said Wednesday it plans to sell some $361 billion in marketable debt this quarter. That's after just over $450 billion or so were sold in the first quarter - $2 trillion is easily in our sights if we continue at this pace.

Among the risks still out there: the fate of the auto makers. The Chrysler negotiations are going down to the wire - and we're only talking $6 billion or so in debt involved. In the battle royal over GM, bondholders have just fired their first shot, according to Reuters. Investors may think that with GM bonds trading at just a couple of cents on the dollar, all the bad news should be already priced in. But last week's swift drop in the dollar against the yen, when the bankruptcy flag was raised for Chrysler, was a healthy warning against complacency.

More uncertainties: the banks. From Goldman Sachs to Deutsche Bank, their first quarter profits came overwhelmingly from trading - fixed income, currencies, commodities. Not even the banks themselves think that's a sustainable model of growth. Not to mention the stress tests, the release of which is turning into a painful farce.

The biggest question mark, though, hangs over the economy, and the consumer in particular. There's a lot stacked up against us (see above) domestically, while the economy slowly wends its way out of recession; the highs in the jobless rate have yet to be seen. Foreign demand won't be much help - the economies in Germany and Japan look likely to have a terrible year.

A closer reading of the Fed statement shows that while policy makers are less downbeat than in March, they remain closely attuned to the risks to the economy. Policy makers are determined to keep long-term rates, so important to consumers and the housing market, low. The consensus that the Fed will expand its Treasury purchases will likely prove right. Now all we need to work out is when they'll tell us.

What To Expect From The Fed On Wednesday

The Federal Reserve's rate setting committee meets on Wednesday - what should we expect from the statement? It's unlikely to be as explosive as the March 18 one (when despite clear signals to the contrary - including a very definitive statement by New York Fed President Bill Dudley 10 days earlier - the FOMC opted to significantly ramp up its mortgage purchase program and to start buying Treasurys to manipulate the yield curve); it could sound a little bit less concerned on the economic front, if the Beige Book and Fed Vice Chair Donald Kohn are anything to go by (but see above, one might want to be careful when reading Fed tea leaves.)

The Treasury market is inclined to push yields higher and test the Fed's mettle - already Friday, the 10-year yield briefly poked its head back above the 3% mark. The thinking is that the Fed will have to buy more than $300 billion worth of government debt to keep long-dated yields in check - and though the consensus seems to be for now that policy makers won't want to announce an expansion of the program, we've learnt our lesson on that (see once again above).

What's more, there are good reasons why the Fed might want to announce an expansion of its purchases now: if policy makers do see some kind of stabilization in the economy, why not double down and make sure the 10-year yield stays below 3% to ensure it stays that way? That's particularly as the consumer remains the weakest link: job losses will continue to rise - April's unemployment rate could touch 9% (it was 5% in April 2008, just for comparison) - and don't be fooled by those who say jobs are a "lagging indicator". That's only a comfort when there's another source of demand (typically exports) that can help get the economy growing again - but remember, this time, we're in a synchronized downturn so that historical leg of recovery won't be of much help.

A freaked-out consumer, terrified of losing his/her job, a global economy mired in a lack of demand - maybe adding another $750 billion to its Treasury purchase program might not be the worst thing the Fed could do.