Wednesday, July 20, 2016
It’s a Brand New Funding Market…Again
Modestly improving housing since March and a rebound in jobs data are but a couple of data points that when however are collected with recent Fed rate prospect rhetoric and a less dramatic and negative response to the UK ‘leave’ vote have had a strong impact on the front end of the yield curve. Since the June 24th post-‘UK-leave’ vote high of 99.41, the nearest to expiry quarterly September 2016 Eurodollar future (EDU6) has fallen by 18.5 bps to 99.225. There has been 13 new session lows within that 17 day period.
While the back-end of the yield curve has reacted, the front-end has led the march for increased likelihood for a firmer Fed policy response. The only way the Fed at this stage would bring forward a firmer policy response is if employment hovered at or below the full employment level of 4.7% and inflation (PCE) was expected to make a more deliberate move toward 2%.
Strength in the dollar (DXY) index, making new 4 month high today, is another indication economic agents are pricing a more aggressive Fed. Some might argue recent activities in Turkey or successive terror events have driven the dollar higher, but the timing of the dollar advance has not shown to be strongly linked to those situations.
Gold prices had seen out-sized gains on the back strong expectations for global central bank liquidity provisions because of believed global deflationary trends, a condition which had more recently found its way into Fed rhetoric. Some of the recent weakness in gold prices may indicate a reduction in expectations for additional massive global central bank liquidity provisions and a more attentive Fed.
We had earlier suspected that the front end of the curve would not find as much selling as has been the case. It has taken a lot of mind-change within the market place on the prospects for growth and inflation for this most recent 3-4 bps to be priced in the front end. At this stage, price action indicates a growing expectation for the Fed to more firmly place the possibility for a September rate response on the table in the statement following the July FOMC meeting next week.