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‘What’flation, 2Y Treasuries Yielding 67bps

June 25th, 2010 Michael McDonough Comments off

Inflation doves can look no further than near record low yields on 2-year Treasuries to squelch inflation hawks ‘premature’ concerns.  The 2-year yield is reflecting the fact that the recovery will remain lukewarm, with downside risks outweighing the contrary, essentially opening up hunting season on Fed hawks—already in small supply. While hawk hunting may be the primary fundamental driver behind recent yields another technical factor may also be playing a role. Chatter on the trading floor is indicating that, private sector deleveraging coupled with a slower pace of government debt issuance is leaving investors with fewer alternatives, helping push yields down across the curve. 

Over the near-term, negative sentiment derived from a housing market left out to pasture, issues in Europe, the gradual removal of government stimulus—a key crutch to recent growth— and a plethora of other geopolitical risks should keep yields and inflationary fears in check for the foreseeable future, while the risk of deflation and an eventual return to negative GDP growth remain all too real.

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Why Central Bank Swaps Haven’t Put a Stop to LIBOR’s Climb

May 17th, 2010 Michael McDonough Comments off

Defying most investors’ expectations, LIBOR’s climb has continued unabated, despite the reopening of the Fed’s Reciprocal Currency Swap lines.    According to the ECB’s records on May 11th seven bidders tapped USD9.2bn of the swaps at a rate of 1.22%, or nearly 100bps above the OIS funding rate.  Ray Stone of Stone & McCarthy Research Associates, may have the best explanation I have been able to find as to why LIBOR has been unaffected by the Fed’s announcement.  In short Ray says that the liquidity provided by the central banks will be available at ‘fixed rates’ that is set ‘roundly 100bps over the OIS funds rate, or equivalent, setting up a penalty rate similar to the Fed’s discount rate.  Ray believes this penalty rate will act as a ceiling on LIBOR, which according to my calculations would presently put a 1.22% cap on 3M LIBOR, compared to a current rate of 0.460%.  Therefore, the mechanisms significant penalty over traditional interbank funding (LIBOR) ‘accounts for lack of impact on underlying money market conditions’.

3M LIBOR vs 3M Treasury

Source: Bloomberg

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Mortgage Rates Begin To Climb

April 7th, 2010 Michael McDonough Comments off

As expected mortgage rates have begun to climb.  On March 31st, as planned the Fed terminated its mortgage backed securities (MBS) purchase program after buying $1.25trn of the instruments–keeping mortgage rates artificially low.  According to the Mortgage Bankers Association (MBA), the average rate for a 30Y mortgage already climbed to 5.31%  the week ending 4/2, compared to 5.04% a week earlier.  I expect rates will continue to climb peaking somewhere between 5.5% and 6.0%, before leveling off.  This will of course but a strain on any housing recovery.  The chart below highlights the Fed’s net MBS purchases and 30Y mortgage rates:

Source: Bloomberg

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Economists Warn Fed Could Hike Discount Rate Before Next Meeting

March 18th, 2010 Michael McDonough Comments off

Economists and investors alike are speculating that the Fed could announce a second hike to the discount rate, after increasing its spread over the fed funds target rate to 50bps–compared to its historical level of 100bps.    Some investors, despite Fed comments to the contrary, perceived the move as prelude to more significant tightening, be it through a reversal of quantitative easing and/or eventual rate hikes.  Further adjustments could have a similar psychological effect on investors, especially given expectations that the Fed could remove or alter the phrase ‘extended period’ from its statement as early as April’s meeting–a clear sign tightening is quickly approaching.

Fed Funds Target (white) Vs. Discount Rate (orange):

According to the latest Federal Funds Implied Probability data, calculated by Bloomberg, the vast majority of investors anticipate no changes to the Fed’s target in April, but looking further out that number diminishes to  66.5% in June.  In an environment of high unemployment, subdued inflation, and what could be tepid growth, I expect August would be the earliest we could expect a Fed rate hike.  Nevertheless, news of another discount rate hike will almost certainly reverberate through the markets, spooking some skittish investors.

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What To Look For This Week

February 22nd, 2010 Michael McDonough Comments off

This week I am going to keep a close eye on several housing reports, which include January’s new (Wed) and existing (Fri) home sales along with December’s Case Shiller HPI (Tue)–December is the first month after what would have been the expiration of the first time home buyer tax credit.  December’s home prices likely came under continued pressure, while January’s home sales data should show at least a modest bounce after their sharp declines in December stemming from the would-be expiration of the tax credit.

I will also be watching a slew of manufacturing releases including three regional Fed surveys–together these surveys can provide some insight on the month’s ISM–and the durable goods orders report (Thu).  I anticipate that all should be positive excluding the Richmond Fed survey.

This week’s biggest news will likely culminate in a flurry of Fed speeches culminating with Chairman Bernanke’s semi-annual monetary policy report to Congress (Wed).  But, given his recent House testimony, coupled with the FOMC minutes he may not have many surprises left to deliver in this week’s testimony.  Nevertheless, markets will be keeping a very close eye on what he has to say, and any comments related to the timing of tightening will likely impact the market.  There are also several other key important Fed speeches this week that could drive some headlines.

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No Surprise, Fed Raises Discount Rate

February 18th, 2010 Michael McDonough Comments off

Chairman Bernanke recently indicated that the Fed was considering an increase in the discount rate, which tends to mean it is going to happen and soon.  It happened, the Fed this evening announced an increase in the discount rate to 0.75% from 0.50%, moving it closer to its pre-crisis spread to the Fed Funds Rate of 100bps.  Undoubtedly, this is a prelude to additional less accommodative monetary policies, which will likely begin with the end of quantitative easing at the end of this quarter, followed the by eventual sale of assets from the Fed balance sheet, and eventual rate hikes for both the target rate and interest on excess reserves.  I do not anticipate we will see a hike in the benchmark rate until at least November of this year, given what I anticipate will be tepid growth and high unemployment.

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Bernanke Comments

February 10th, 2010 Michael McDonough Comments off

It looks like over the short-term the Fed will be using interest on excess reserves as its primary monetary policy tool to aid in its removal of excess liquidity from the market. This is the interest rates paid to banks on excess reserves held at the Fed.  These comments continue to indicate accommodative monetary policy for the foreseeable future, but have set out a blue print on how eventual tightening will likely start to occur.

Other Bernanke Comments That Came Across my wire:

-10:00 02/10 BERNANKE: ECON CONTS NEED ‘SUPPORT OF HIGHLY ACCOM MON POL’

-10:00 02/10 BERNANKE: WILL EVENTUALLY RETURN TO FED FUNDS AS POLICY TARGET

-10:00 02/10 BERNANKE: ‘IN DUE COURSE’ MUST TIGHTEN ‘AS EXPANSION MATURES’

-10:00 02/10 BERNANKE: DON’T EXPECT SEC’TIES SALES TIL TIGHTENING UNDERWAY

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ECB President Trichet Leaves Sydney Early to Attend Emergency Meeting

February 8th, 2010 Michael McDonough Comments off

ABC News (Australia)is reporting that, “A Reserve Bank official says the head of the European Central Bank, Jean-Claude Trichet, is leaving a Sydney meeting of central bankers early to attend an ECB council meeting.” I expect this means investors could anticipate some market moving news related to troubled EU nations over the next few days.

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Bullard Comments on Monetary Policy, Indicating a Fed Rate Hike Not Likely Over the Short-Run

February 8th, 2010 Michael McDonough Comments off

According to CNBC, James Bullard,President Federal Reserve Bank of St. Louis, indicated in an interview today that *he does not believe the Fed will begin hiking interest rates, until after they start selling off some assets. He anticipates that the Fed could begin selling assets during the second half of this year. Bullard had this to say on asset sales, “Maybe you get in the second half of 2010 or something like that, if things are going pretty well, maybe then you’d sell a little bit at that point and you’d try to see how the market reacts.”

In investors’ minds Bullard’s comments will likely reduce the probability of a near-term rate hike, and also help define the parameters for future hikes.  I presently do not anticipate that we will see a Fed rate hike until November 2010 at the absolute earliest.

*I heard this reported on CNBC, but have not yet found the quote to support this statement.

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Hoenig Dissent Only Surprise in FOMC’s Statement

January 27th, 2010 Michael McDonough Comments off

As anticipated the FOMC reaffirmed that it “will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions…are likely to warrant exceptionally low levels of the federal funds rate for an extended period.”  But, a hawkish sign came in the form of a dissenting vote from Kansas City Fed President Thomas Hoenig–a known inflation hawk.  This could be an indicator that the Fed is testing the waters for eventual tightening, which are likely still a ways off.  I do not anticipate we will see any changes to the Fed’s benchmark rate until the labor market realizes significant improvements, which I can’t imagine will be prior to November 2010 due to below trend growth rates.

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