Need To Know News

Interest rate futures markets indicate a foregone conclusion to this afternoon’s rate announcement, as the Fed is widely expected to leave the Fed funds rate unchanged at 2%. Recent Fed speak has hinted at forthcoming rate increases, despite the prevalence of downside risks; however, the continued struggles in the credit market and deteriorating market confidence should leave the Fed’s hands tied.

Front month Fed fund futures are nearly unchanged on the day and currently show a 93% chance the Fed will leave rates unchanged this afternoon. Fed fund options fall directly in line with front month futures, also indicating a 93% chance the Fed funds rate will be left at 2%.

Binary options show a 95% chance the Fed will leave rates unchanged this afternoon, along with a 3.8% chance of a 25bps hike and a 1.1% chance of a 50bps hike.

Euro$ interest rate futures are mixed after some volatility surrounding the employment report and subsequent ISM and construction releases. CME Group sources remain stumped by the resilience of the short-dated rate contracts, but argue for more curve steepening into next week’s FOMC meeting.

Accordingly, the nearby Dec-08 contract is off 2-ticks at 96.985, while the deeper deferred contracts are higher by as much as 4-ticks. Early option activity was mixed, though some bullish trades have emerged more recently.

About 20k in demand for “calls and call spreads” on the Dec-08 future have been reported, perhaps contributing to the underlying pop from session lows of 96.95. Charts provide support at 96.94 for another run higher at 97.095 resistance at a minimum.

Euro$ interest rate futures have extended a bullish streak heading into tomorrow’s payrolls report; which now contains firmer than expected ADP reading, a weak Monster.com index (seasonal) and a very weak jobless claims reading (special factors) for guidance. The Dec-09 contract jumped to highs of 97.06 this morning before paring those gains back to 97.025 (up 5-ticks), still well up from lows near 96.69 last week. Early option activity included a large bullish 15k bid for “call butterflies” on Sep-08s, among other trades — the same European bank bought 15k yesterday. Technical risk is building for a pullback now to 96.85 (especially on a better than -60k payrolls print Friday), before turning higher again to challenge 97.095.

Fed funds futures have shifted slightly lower today after the ADP employment and final Q1 productivity numbers came in better than expected. Implied rates are still heavily weighted toward a steady FED policy stance with a 2% funds target through the fall. June futures show a 96% chance of no cut at the upcoming FOMC.

The December implied rate, however, is reflecting a roughly 50-50 chance for a 25bp rate hike by the end of the year.

Fed Fund futures are slightly lower and currently show an implied rate of 2.06% which shows a 76% chance of a 25 bps cut this afternoon. Fed Fund Binary Options at yesterday’s settlement showed a 96% chance of a cut to 2% this afternoon. Fed Fund options show a 71% chance of a 25 bps cut and a 24.5% chance the Fed will leave rates unchanged.

Bonds are nearly unchanged save for some buying into the 30yr which is up 0.2% with a yield of 4.531%. The 10yr is yielding 3.812%, the 5yr yield is 3.118% and the 2yr is yielding 2.375%. The short end of the curve is catching a decent bid with the 4week bill yield down 7 bps to 1.2%, the 3month bill yield down 4 bps to 1.42% and the 6month bill yield down 2 bps to 1.71%.

USD is mixed ahead of this afternoon’s rate announcement with EUR/USD flat at 1.5567, Cable up 0.72% to 1.9838 and USD/JPY up 0.33% to 104.38.

The recent history of the FED FUND/DISCOUNT RATE spread is one of narrowing. The history of the spread adheres to the business cycle with the Discount Rate below FED Funds during recessionary times and above FED Funds during boom times.

This flip-flopping of rates usually lags a slowdown, but not by much. Will today’s decision cut the Discount Rate below the FED Funds rate?

FED Funds have priced in a 100bp rate cut; to get the discount rate under that, the FOMC would have to cut 150bps, assuming 25bp increments. To pull the Discount Rate in line with FED Funds, the FOMC must apply any FED Funds cut plus 25bps to the Discount Rate.

Remember, the Discount Rate gets pushed below FED FUNDS during slow growth/recessionary times, so it seems like a good time to push the Discount Rate sharply lower.

FED Fund futures now show the chance of a 10bp cut at 88%, up from 52% on Friday. A 125bp cut is now also now in the mix, with futures showing a 12% chance.

Euro$ Futures have jumped above 98, climbing as high as 98.255.