Friday, June 5, 2009
The headlines today are all about how job losses were a lot less than he market had expected (345K vs. 520K). But the biggest mover in the markets so far is the Eurodollar futures contract tied to what Libor will be in December 2010. As this chart shows, it fell almost 37 bps, which means that the expected Libor rate rose 37 bps. That rate is up by 50 bps between Wednesday and today. Since Libor is typically linked closely to the Federal funds rate, this implies that the market has suddenly adjusted upwards—by 50 bps—its expectation for where the funds rate will be at the end of next year. On Wednesday the market thought the funds rate would be about about 1.75%. Today it is thinking 2.25%. That's a big deal, suggesting that the market is now beginning to get comfortable with the idea of a recovery.
It should also be viewed as a warning shot across the Fed's bow: they better start gearing up for tightening, because they're going to have to abandon quantitative easing and start raising the funds rate. If they do it in 25 bps increments, they are going to have to raise the funds rate every 2-3 months or so, according to the market's best guess today.
It's also significant to note that gold dropped sharply today and the dollar rose. That's perfectly consistent with a market that is realizing that the Fed is probably not going to be forced to keep the pedal to the metal forever; that higher interest rates are coming into view. If the Fed gets the message and starts raising rates, that would be very good news indeed. Because otherwise, we are going to have a big inflation problem on our hands.
UPDATE: As the bond market gets ready to close, the Dec. '10 eurodollar contract is trading with a yield of 2.71%. That translates into an expected funds rate of almost 2.5%. The yield on the 2-year Note is up 35 bps. The yield on 2-year Treasuries has been pretty stable since the end of January at about 0.95%, and now it is suddenly up to 1.3%. Think of the 2-yr yield as the market's best guess for what the funds rate is going to average over the next 2 years. This is a clear sign that the economy is now in recovery mode. Stocks are nervous over the jump in rates, but shouldn't be. We are many, many months away from interest rates or Fed policy even beginning to pose a threat to the economy.
Posted by Scott Grannis at 8:34 AM