From www.bloomberg.com today, June 9
“The Wall Street firms that trade directly with the Federal Reserve say speculators betting that interest rates may head higher this year are wrong.
Policy makers will keep the target for overnight loans between banks in a range of zero to 0.25 percent this year, according a survey of 15 of the 16 primary dealers of U.S. government securities that trade with the central bank. A majority predict no increase until at least the second half of 2010. Cantor Fitzgerald & Co. officials weren�t able to immediately provide a forecast.
Yields on two-year Treasury notes surged 44.4 basis points June 5 and 8, the biggest two-day increase since Sept. 18 and 19, and Fed funds futures contracts show a 58 percent probability of a rate increase by November on signs that the economy is bottoming. Implied yields on eurodollar futures, also used to speculate on changes in central bank policy, increased even as the U.S. government said on June 5 that the unemployment rate rose to 9.4 percent, the highest since 1984.”
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We find this news article quite interesting. Essentially it seems that the biggest dealing desks are at odds with the market participants. So will the “smart money” dealing desks, with their connections to the US Fed, and their quantitative pricing models be correct, or will the markets view win out? Remember that markets are affected by George Soros’ theory of reflexivity, which poses that markets are effected by participants’ actions, thereby effecting the market’s fundamentals.
In this case the “house” (bond dealers) and the “players” market participants are at odds. We will be watching the yield on the 10 year US Treasury Note as it closes in on 4% to see where the line in the sand is drawn by the dealers.
The interest to currency traders is that as longer term interest rates have moved higher, the short term rates controlled by the US Fed stay low. This creates a steepening of the yield curve that implies inflation in the future. That change in the steepness of the yield curve is what has hurt the USD over the last two months. Inflation will erode the value of the USD.
So keep an eye on the yield curve to see if as the yield on 10 year Treasuries closes in on 4%, the market and the US Fed start to raise the short term rates which would lessen the steepness of the yiueld curve. This would be bullish for the USD.
Stay Nimble!
Stephen Leahy
Back Bay FX Services, LLC
www.backbayfx.com