Recap 1-25-12

Main Items:

  • FOMC:
    1. Statement: “Anticipates ‘exceptionally low’ rates through at least late 2014.”
    2. 11/17 members see Fed Funds above 25bps in 2014
    3. 9/17 see Fed Funds below 1% at YE2014

  • FOMC 2012 Forecasts:
    1. Growth of 2.5% vs 2.7% in Nov
    2. Core PCE at 1.65% vs 1.75% in Nov
    3. Unemployment at 8.35% vs 8.6% in Nov
    4. ‘Longer Run’ Fed Funds rate of 3.75% to 4.5%
  • The FHFA house price index increased 1.0% MoM in Nov, the largest gain since March 2005, vs 0% exp. The mid-Atlantic (NY, NY, Penn) was the only region to show a decline.
  • Pending Home Sales growth decelerated to 4.4% in Dec vs 6.9% prev
  • Obama’s STOU speech included plans to allow current, underwater homeowners to refinance, but details were not yet available, and appear to need congressional approval, which will be difficult to achieve.
  • MPC minutes showed that it expects “output was likely to be broadly flat in 2011Q4 and 2012Q1.” Separately, King gave a dovish speech last night whereby he re-iterated expectations for a long recovery and lower inflation.
  • Hedge Funds Scramble to Unload Greek Debt – Dealbook


  • German IFO Business Climate Index improved to 108.3 in Jan vs 107.6 exp and 107.2 prev
  • UK GDP increased 0.8% YoY in 4Q as exp vs 0.5% prev
  • AU CPI declined to 3.1% YoY in 4Q vs 3.3% exp and 3.5% prev.
  • The Japanese trade balance turned into a deficit (JPY 2.5 trillion) in 2011 for the first time since 1980


The Fed appeared surprisingly dovish, but did not indicate why, given that unemployment has been falling. The FOMC knew that consensus expectations for the first hike was in 2Q2014. Possible explanations, ordered by likelihood:
1) the statement simply reflected the fact that a preponderance of members forecast a hike by the end of 2014
2) the FOMC simply wants intermediate US yields to stay in a narrow range until unemployment falls further.
3) the FOMC wanted to ease further while avoiding a QE program in an election year. As a result, this front loaded guidance based ease was meant to replace a QE program later this quarter

As a result of this, 5y treasury yields hit a new low, and blue Eurodollar futures (2015 maturity) lead the rally, up about 20bps on the day. The Dec 2015 contract is at a ~1.85% yield. If we assume Libor-OIS of 40bps, and Fed Funds Target – OIS of 15bps, this implies an average Target Fed Funds rate of ~1.30% in 4Q2015, or 4 hikes. In my opinion, the risk is now definitely 2 way. While the positive carry in this sector of the curve remains attractive, it is unclear if that will lead to profits given fair value estimates. 4 years is a very long time for economic forecasting, where accuracy beyond 2 quarters is worse than naïve extrapolations. The 2014 date is a forecast, not a commitment, and could change. And there may a different chairman by then as well.

As a result, I think there is a reasonable possibility that we got a near term low in US yields this afternoon. I am taking profit on the USD 3y1y receiver trade today.


2 thoughts on “Recap 1-25-12

  1. Just can’t fight the fed…more work to do at lower yields to stop out the shorts before yields can go higher?

    1. That’s possible, although most positioning data (i.e. 5yr futures positioning) suggests speculative players are very long. It’s not clear now what will turn yields around unless US growth surprises substantially to the upside and the Fed stops stomping on the ease pedal. You’d think the that string of better economic data as well as reduction in EU risk premiums would have driven at least a modest correction, but for now, as you say, we can’t fight the Fed or the price action.

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