Tuesday, March 17, 2015

Fed ‘NOT’ Priced to Drop ‘Patient’ Language

Treasuries and Eurodollar are higher this morning following a weaker housing number, though the permits were indicative of some forthcoming progress.  Futures started strong immediately following the opening last night. 

Trade yesterday was on light volume and mixed open interest results. TY found a 16k decline in o.i., but the 164K decline in ED’s was on the back of 153K lost with EDH5 expiry.  Otherwise, another ho-hum bid that has been the repeat since the close from the last employment report.

Tomorrow the  widely anticipated FOMC statement, SEP and post-meeting press conference is upon us and at this point it is hard to imagine too many who are short and without deep pockets to withstand the upward pressure that has been exerted over the last 7 sessions.  The base line expectations for FOMC are as follows:
·        Fed Drops Patience
·        Fed Lowers Unemployment Expectations
·        Fed Reduces Recent Growth Assessment
·        Fed Emphasizes Data Dependency
·        Fed Lowers Year-End ‘dot-plot’ for 2015

The market trades as if the ‘patient’ language stays and that the softer economic reports lately will have swayed Fed officials from moving forward with ‘normalization’.  There is certainly reason to consider this as an option for the Fed.  I believe however the Fed is particularly interested in moving forward with normalizing policy for many reasons, financial stability one, and will accept a pace of growth closer to 2% and inflation forecasted to reach 2% within 18-24 months as sufficient to proceed. 

If I am correct in anticipating that the market has priced the Fed keeping ‘patient’ language and lowering recent growth assessment, then there is room for lower Treasury and Eurodollar prices following the FOMC meeting.  If the ‘patient’ language is removed and not as much concern is expressed in the recent spate of weaker economic reports, then selling (in the front end of the curve) might be more pronounced.

The long end may have been driving the short end of the yield curve over the last week more than we are aware and the next leg lower in Treasury and ED prices may find the front end of the curve going it more alone.  The Treasury 5-30 yield spread is roughly 7 bps tighter to 1.08% from the last employment (mkt recent low) and we should expect 2’s and 5’s to underperform on any selling following the FOMC report.  

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