March 30. Ending the quarter with diminished tightening expectations

–Ten year treasury yield fell 6.4 bps Friday to 194.6, reversing a large part of Thursday’s jump to over 2%.  Not much change in the curve, as reds, greens, blues and golds (eurodollars) were all up between 6 and 7 bps.  EDM’15/EDU’15 (Front June/Sept) euro$ spread posted a new recent low of just 15.5 bps – the market is lessening the odds of near term rate increases.  Yellen’s speech late Friday reinforced that theme, repeatedly noting that rate increases would be gradual.  Additionally, she cited the (stark?) difference between the Fed’s relatively optimistic forward scenario with that of the market: “That said, it is sobering to note that many market participants appear to assess the risks to the outlook quite differently. For example, respondents to the Survey of Primary Dealers in late January thought there was a 20 percent probability that, after liftoff, the funds rate would fall back to zero sometime at or before late 2017.  In addition, both the remarkably low level of long-term government bond yields in advanced economies and the low prevailing level of inflation compensation suggest that financial market participants may hold more pessimistic views than FOMC participants concerning the risks to the global outlook.”
–The big mover on Friday was crude oil, which plunged $3/bbl to close below $49.  The concern of the developed economy CBs continues to be risks to the inflation outlook and oil is certainly front and center.  To my way of thinking, it’s just another way of saying that cash flows from assets might not be enough to cover debt servicing in an overleveraged global economy.  This issue is underscored by China:  (Reuters) – “China’s central bank governor Zhou Xiaochuan warned on Sunday that the country needs to be vigilant for signs of deflation and said policymakers were closely watching slowing global economic growth and declining commodity prices.” Nearly 7% growth and concerned about deflation?  No.  The worry is that waves of debt defaults will cause asset fire sales, which feed on themselves.
–Turning back to market prices in US interest rates, note that treasury prices have not only completely negated the initial bearish move from the payroll report earlier this month, but are also mostly above the closing levels of the payroll release in February.  The market is sending a clear message endorsing Yellen’s view that rate hikes are likely to be gradual.  As a final price point, consider January 2016 Fed funds (FFF6) which closed Friday at 99.53, or only 47 bps, just 1.5 bps lower than the highest settlement of the year.  At the very end of last year, this contract traded below 99.25.  So in the first quarter, more than a 1/4% of prospective tightening has been squeezed out of the market. 

Posted on March 29, 2015 at 4:13 pm by alexmanzara · Permalink
In: Eurodollar Options

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