March 30. On the one hand, on the other hand… Yellen’s speech one big disclaimer

–That may have been the lamest Fed Chair speech I have ever read.  In the spirit of Dodd-Frank the entire thing was one big disclaimer.  Let me paraphrase, we hiked but I’m not sure that we should have.  There are a lot of risks facing the economy, both internally and from abroad.  We think inflation will eventually go up but we’re not sure, our forecasts haven’t been good, and because of asymmetric risks we’re just going to watch from the sidelines. But don’t worry, because the MARKET prices in fewer hikes when things are crappy, which cushions the fall.  The Fed is impotent.
–The reaction was swift.  Sell the dollar, buy risk, buy gold, buy steepeners, sell vol. The ten year note yield fell nearly 6 bps to 181.2, but the ten year inflation indexed note yield crashed 12 bps to 18.8. (In December the ten year tip yielded 80 bps).
–Once again, one-year euro$ calendars are flat: the first ten one-yr spreads are all between 25 and 27.5 bps.  However, deferred spreads firmed while near spreads declined.  The green pack (3rd yr) rallied by 8.125 bps, while golds (5th yr) were only up 5.375.
–What I found interesting about this speech was how many times Yellen cited the market and interest rate curve.  She still has it wrong, by implying that the long end adjusts to economic data simply by altering the expected path of Fed hikes, as if it all starts and ends with the Fed.  In actuality, the Fed just continues to distort markets and mangle its communication.  Having said that, it felt to me as if early market action indicated that someone selectively communicated the contents of this speech prior to its actual release.

–Here are speech excerpts noting the influence of the market:
“In part, the baseline outlook for real activity and inflation is little changed because investors responded to those developments by marking down their expectations for the future path of the federal funds rate, thereby putting downward pressure on longer-term interest rates and cushioning the adverse effects on economic activity. In addition, global developments have increased the risks associated with that outlook.”

“But those effects have been at least partially offset by downward revisions to market expectations for the federal funds rate that in turn have put downward pressure on longer-term interest rates, including mortgage rates, thereby helping to support spending.”

“Financial market participants appear to recognize the FOMC’s data-dependent approach because incoming data surprises typically induce changes in market expectations about the likely future path of policy, resulting in movements in bond yields that act to buffer the economy from shocks. This mechanism serves as an important “automatic stabilizer” for the economy.”

Why bother with Fed policy if the long end of the market preempts policy?

And here are the disclaimers:
“That said, this assessment is only a forecast. The future path of the federal funds rate is necessarily uncertain because economic activity and inflation will likely evolve in unexpected ways.”

On inflation: “too early to tell if this recent faster pace will prove durable.”

“Given the risks to the outlook, I consider it appropriate for the Committee to proceed cautiously in adjusting policy. This caution is especially warranted because, with the federal funds rate so low, the FOMC’s ability to use conventional monetary policy to respond to economic disturbances is asymmetric.”

And to wrap it all up: “As has been widely discussed, the level of inflation-adjusted or real interest rates needed to keep the economy near full employment appears to have fallen to a low level in recent years.”

Posted on March 30, 2016 at 5:23 am by alexmanzara · Permalink
In: Eurodollar Options

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