Sept 6, 2017. Low R* means low rates
–“In the environment of the last few years, markets have become very comfortable in interpreting the lack of official guidance on the policy normalization as a green light to increase financial bets on the continuation of a low volatility journey, delaying the important consideration of (and positioning for) the destination.” This quote is from an El-Erian piece this morning on Bloomberg regarding Thursday’s ECB meeting tomorrow.
https://www.bloomberg.com/view/articles/2017-09-06/what-the-ecb-will-and-won-t-do-this-week
–“By constraining the amount of policy space available to offset adverse developments using our more effective conventional tools, the low neutral rate could increase the likely frequency of periods of below-trend inflation. In short, frequent or extended periods of low inflation run the risk of pulling down private-sector inflation expectations.” From Brainard’s speech yesterday.
–El-Erian suggests that CB reticence to move towards normalization is spurring financial engineering. Brainard is concerned about the low neutral rate [R*] and low inflation expectations which are self-reinforcing. The central bank problem is a circular one, made more complex by currency trends which affect inflation through import/export prices. While the ECB meets tomorrow, the FOMC is in two weeks, and will include the ‘dots’ which may shift lower in the longer run.
–Interest rate markets were fairly quiet yesterday in the face of increased tensions with North Korea and potential damage from Hurricane Irma. The ten year yield dropped 8.5 bps to 207 (from Friday’s close). 2/10 treasury spread closed at 78.4, down 2.7 on the day to a new low. Nearly all eurodollar calendars made new lows on the year. EDH18/EDH19 was crushed to 17 from a settle of 21 on Friday. Both Brainard and Kashkari suggest that rate hikes should be deferred. In Fed Funds, Jan’18/Jan’19 settled 15…roughly a 60% chance of just one hike for all of next year. It was a steady and controlled shift to an environment of lower rates.
–Implied vol firmed, but only modestly. A jump in VIX was hammered down like an errant nail by the close. There were some wingy buys, for example, +40k each 0EZ 9900c for 1.0 and 9912.5c for 0.5 (settled 0.5 and 0.25).
–Today’s news includes Internat’l Trade, non-Mfg ISM expected 55.8, and the Beige Book.
