Thursday, June 1, 2017
Locking in a June Fed Hike – Implications for Curve
June 2017 Eurodollar future (EDM7), the nearest to expiry contract, trades last at 98.7325. This is 2 basis points (bp’s) lower from yesterday’s close and 1.75 bps lower from the opening level of 98.75. The pricing of EDM7 currently receives great attention because of its implications for the likelihood of a Federal Reserve policy rate adjustment. Given the proximity to tomorrow’s May employment report, it is somewhat unlikely that EDM7 would move by as much as it has already today.
While 1.5-2.0 basis points may not appear as much, the nearest to expiry Eurodollars contract has only moved an average of 0.6 bp (open to close) per day over the last 5 years. More recently, in the last 100 days, that average has increased to just over 0.9 bp per day. In any event, today’s movement is exaggerated. More generally, US Treasury and Eurodollar futures have muted ranges in the session(s) prior to the employment report as the importance afforded the employment report largely reduces prior news as mere ‘noise’. We are advised to take note when outsized price movement occurs prior to the employment report as this may indicate market participants have made new unyielding commitments.
It is tempting to extrapolate the insight value of this EDM7 move across the entire Eurodollar and Treasury curve, but more to the point, the weakness seen today in EDM7 indicates a willingness to move beyond the employment report to pricing a greater likelihood for a Federal Reserve rate hike at their upcoming June 14th FOMC meeting. The market had already priced a strong likelihood for the Fed to raise rates, but there has still been some holdout as weaker Q1 economic growth and recently softer inflation reports prompted some to question the Fed to resolve to gradually lift policy rates.
For guide, funding conditions have had a strong influence on the pricing of EDM7 over the last months. Consideration of these conditions has tightened the spread between Fed Funds (policy rates) and unsecured funding (Eurodollars, etc). The Libor (London Interbank Offered Rate) / Overnight Index Swap (OIS) spread has tightened from nearly 25 bps in late-March to under 12 bps today. Unchanged funding spreads would suggest that EDM7 would settle at around 98.977 if the Fed were to refrain from hiking in June. Under similar conditions and with a 25 bp June 14th rate hike, EDM7 will likely settle toward 98.727.
As an aside; The dramatic shift in positioning by CFTC described ‘non-commercial’ accounts (sometimes called ‘large spec’) in Ten Year Treasury Futures from a record net short (futures and options) at the start of the year to the biggest net long since late ’07 gives rise to expectations that the risk to the June 2, release of the May Employment report is toward higher rates/lower USTreasury prices.