- US money market rates are above last week's highs.
- The dollar is finding some traction on this.
- The ECB risk is in the other direction.
US money market rates are rising today, extending the increase last week spurred on by the FOMC meeting and comments by Fed chief Yellen.
The December 2015 Fed funds futures contract is implying an effective Fed funds rate of 85 bp. This is about 5 bp more than the market's initial reaction last week. At the extremes in January, the contract was implying about 88 bp.
The December 2015 Eurodollar futures contract implies a yield of 1.22%. This is also about 5 bp more than seen last week. The high watermark, this year, was about 1.27%.
This is translating into higher 2-year US yields, as well. The yield is about 11 bp higher than last week's lows and at about 45 bp is the highest since last September. It began the month near 30 bp.
If one were to take the 8 bp of the Fed funds rate and continuously compound for two years, it would translate into a 16 bp yield. This would suggest that the current two-yield has a 25 bp hike discounted.
Even if Yellen's attempt to define a considerable period was ill-conceived - a mistaken abandonment of strategic ambiguity - and the first rate hike is not around six months after the asset purchases are completed, but for a "considerable period" after that, there is no reason to think the 2-year note cannot rise further in the period ahead.
The German 2-year yield is being constrained by ideas that the ECB may still ease policy. The net effect has been to widen the 2-year interest rate differential to about 25 bp. The link between the 2-year differential and the euro-dollar exchange rate appeared to have broken down through most of the first quarter. However, since the FOMC meeting last week, the two appear to be re-coupling, and the greenback is finding better traction.
We see some risk that the Fed officials are trying to "clarify" Yellen's comments. However, it is disingenuous to argue that 1) she did not say anything that was not already picked up in surveys and market expectations as Bullard tried to suggest before the weekend and 2) that the dot-plot of forecasts do not matter. However, looking at the week's slate of Fed speeches, we don't see much of an opportunity, until perhaps Evans' late in the week.
The longer the Fed waits to do so, the harder it may be to restore the status quo ante. After a rather poor start to the year in terms of economic data, the worst appears to be behind it, and stronger data is expected going forward. The early call for the March employment report is the 188k in nonfarm payrolls. If accurate, it would be the third consecutive monthly improvement: each month was stronger than the previous month since the lowly 84k increase in December.
The day before the US employment report, the ECB meets. This week's money supply and lending data will help shape expectations. The pace of LTRO repayments have increased over the past couple of weeks and was almost 19 bln euros for this week alone, which is five times greater than average weekly pay down a month ago.
Some of it could be linked to an Italian bond that matures on April 1 (March 21 was the last day to notify the ECB of the repayment related to the freeing up of funds related to this maturity). The ECB may also hold some of this paper under its SMP program. If true, when this issue matures, it would reduce the amount the ECB needs to sterilize.
At the very least, Draghi can be expected to weigh in against the euro's strength. Many are skeptical that jawboning alone can work, Draghi has been very successful in combining deeds (rate cuts at his first two meeting and two LTROs) with words ("do whatever is necessary") and OMT (which has not nor will likely be operationalized).