Feb 19. Is the Fed afraid of losing ‘control’ ?
–Wednesday began with a test of the 217 yield, the 38% retracement of the move from the end of 2013 to January of 2015, from 303 to 164. There were technical bids at that level that held. The day was fairly quiet going into the FOMC minutes, but the headline blaring “Many Fed officials inclined to stay at zero longer” caused a ripping rally in interest rate futures. TYH jumped from 127-15 to 128-08 and then settled back. Ultimately, the ten year cash yield fell about 8 bps to 206. While the headlines were decidedly dovish, in reading the minutes I was struck by the generally positive economic tone, though international risks were acknowledged. I was further amazed by the hand-wringing over taking out the word “patient” and the possibility of markets “overreacting”. Such a debate reflects institutional hubris. The dots have been far off the market since inception. Does the Fed really think that minor tweaks in communication cause lasting adjustments in interest rate markets? I guess the taper tantrum episode in summer of 2013 made a deep impression.
–It’s worth taking a look back at 2004. The first actual hike was on June 30, from the then low FF target of 1.00% to 1.25. The EDU04 contract went from 9864 on April 1, to 9800 on May 14, a 64 bp move prior to the actual rate hike. That’s what markets do, anticipate and adjust. So, at 9864, the contract was about 36 bps above the Fed effective. Now EDU15 is 9942, about 46bps above the current Fed effective rate. So in historical context I don’t think things are way out of line for a coming rate hike. The Fed’s preoccupation with financial stability is misplaced. Not that we may not see enormous financial INSTABILITY, I think we will, but the Fed is unlikely to spark it just by changing a word…it’s much more likely to arise out of the global debt implosion at negative rates.
Chart of EDU 2004. First Fed hike on June 30
–There were some large buys in interest rate futures prior to the minutes. For example, a new buyer of 10k TYK 127/130/133c fly for 38 (settled 43). Also large outright buys in dollars. Implied vol in treasuries firmed. The TYM 126.5 (atm) straddle settled 3’05 on Tuesday, but the TYM 127.5^ settled 3’11 yesterday.
–News today includes Jobless Claims at 290k, Philly Fed expected 8.2 from 6.3, and Leading Indicators, expected +0.3. Maybe the drop in oil prices hasn’t had much of a negative effect on the US, but the Bank of Mexico cut its growth forecasts due to lower oil prices and less final demand.
