Jan 12. Lower yields on Friday. New lows in near Euro$ calendars. Watch Financial Conditions.

–First, notes about Friday’s trade.  Yields continued to sink, as wage data from Friday’s employment report was weak.  Even though several investment banks said that across the board wage declines suggested the data was a fluke, the trend had already been set for the day.  Tens fell 4 bps to 197.5.  Front end eurodollar spreads made new lows, suggesting that the market has pushed back both the timing and aggressiveness of the Fed tightening schedule.  As recently as early October, the largest one-yr eurodollar calendar spread was as high as 112 bps.  The current peak spread is still Sept’15 to Sept’16, but it is now only 88.5 bps, having dropped 3 bps on Friday.  The big trade anticipating the rally and curve roll, a buy of 100k EDZ’16 on Thursday between 9827.5 and 9830.5 was a big winner, with that contract settling up 7 bps to 9836.5.  Straddles were immediately hit after the data, but then found support.  TYH 128.5^ was 2’05 early morning but settled at 1’63.
–Though the dollar weakened slightly on Friday, both oil and euro are pushing for new lows this morning.  Interesting on Friday that gold had a fairly strong rally, associated with the dollar which softened only in the context of a pause.
–Last week Hilsenrath had mentioned a speech by the NY Fed’s Dudley, which is quite an interesting read (the actual speech, that is).  The quote that might be of focus:  “Let me be clear, there is no Fed equity market put.”  Which perhaps should be lumped into the same category as “Read my lips, no new taxes.”
Here is a link: http://www.newyorkfed.org/newsevents/speeches/2014/dud141201.html
–The speech is from Dec 1, and mainly considers monetary policy in the context of financial market conditions.  He spends some time praising the Taylor Rule…”First, it very explicitly focuses on the two parameters—the long-term inflation objective and the level of potential output consistent with that objective—that map directly to the Federal Reserve’s dual mandate objectives.  Second, standard Taylor Rules are self-equilibrating.  They respond to economic shocks and forecast errors in a way that pushes the economy back toward the central bank’s objectives. …Third, academic research shows that Taylor-type rules typically perform quite well across a wide range of economic models.”  However, he then concludes that more subjective policy making is needed.  Ironically he essentially said the Fed erred in its previous TWO recent policy endeavors.  “First, during the 2004-07 period, the FOMC tightened monetary policy nearly continuously, raising the federal funds rate from 1 percent to 5.25 percent in 17 steps.  However, during this period, 10-year Treasury note yields did not rise much, credit spreads generally narrowed and U.S. equity price indices moved higher.  Moreover, the availability of mortgage credit eased, rather than tightened.  As a result, financial market conditions did not tighten.”  Conclusion, the Fed didn’t tighten aggressively enough in 2004-06.  “Second, during the financial crisis, especially during the fall of 2008, financial market conditions tightened dramatically even as the FOMC was cutting its federal funds rate target to zero.  Monetary accommodation turned out to be insufficient…”
–If the Fed never really gets it “right”, then why should we buy into the need for subjective rule making?
–This note is already a bit long, but the St Louis Fed helpfully publishes a “Financial Stress Index” that bears watching.  http://research.stlouisfed.org/fred2/series/STLFSI
Here is the list of data that goes into the index:
http://www.stlouisfed.org/newsroom/financial-stress-index/key/
As a summary, despite junk bond spreads widening, etc, this index shows little signs of stress, though is has turned up in the past several months.

 

fredgraph FIN STRESS

 

 

 

Posted on January 12, 2015 at 5:12 am by alexmanzara · Permalink
In: Eurodollar Options

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