Brainard: Fed Funds First!

-Yields soared as the market continues to adjust to the idea that the Fed is pushing up its rate hike schedule.  Brainard’s speech last night was another important voice giving a blessing to the transition to gradual rate increases; more on the speech below.

–From Tuesday’s close of open outcry, the ten year yield jumped 10.6 bps to 246.2.  The eurodollar curve, which had initially flattened Tuesday afternoon, steepened fairly aggressively yesterday, with reds -7.625, while greens, blue and golds were -11.125, -12.25 and -12.5.  2/10 treasury spread popped 3.5 bps to 117.8.  There was one large put spread buyer in red and green midcurves, all 25 wide put spreads in size of 40k in June, Sept and Dec; details below.

–Fed fund contracts in March and April now indicate about 75% chance for a March hike. Given the current Fed effective of 66 bps and expected move to 91 bps, the June 2017 FF contract at 9908 (or 92 bps) indicates certainty of a near term hike with a teeny bit more priced in at the June meeting.  June FOMC is on the 14th of a 30 day month.

–What is somewhat astonishing is lack of a vol bid.  There is not even a whiff of panic.  Most atm straddles were unchanged, or in by 0.5 bp.  Perhaps that’s understandable in USM where the atm straddle went from 6’02 to 5’50 as the 5/30 spread notched a new low to 108.  But I would say for example, that 2EJ 9775 straddle at 23 bps is simply the wrong price.  In the past few days the contract has moved 22 bps (Friday high to yesterday close).  I would also note that there was quite a bit of ‘French election trade’ exits, i.e. buying back of May treasury premium which expires before the election and selling out June, which expires 26-May.  Caught out by gamma.

–The first line of Brainard’s speech says it all: “The economy appears to be at a transition. We are closing in on full employment, inflation is moving gradually toward our target, foreign growth is on more solid footing, and risks to the outlook are as close to balanced as they have been in some time.”  She had previously been very cautious, but is embracing a transition, even though she continues to point out foreign risks, especially with respect to China.  Another telling line:   “Recent months have seen an increase in the upside risks to domestic demand.”  In terms of monetary policy, she discussed increasing Fed Funds versus trimming the balance sheet; she favors a policy of Fed Funds First…”subordination” of changes in the balance sheet to more typical changes in FF, in part to re-stock ammo in case of a downturn.

–Large midcurve put buying: 40 k each, all 25 wide put spreads. In 0E (red mids) June 9812/9787 8.75s, Sept 9800/9775 9.0s, Dec 9750/9725 8.0s. Paid 27-27.5 settled 25.75.  In 2E (green mids) June 9750/9725 5.0s, Sept 9737/9712 5.75s, Dec 9725/9700 6.5s. Paid 19.0 settled 17.25.

Posted on March 2, 2017 at 5:03 am by alexmanzara · Permalink
In: Eurodollar Options

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