Monday, 20 October 2014

On the USD and US rates

Last week we saw quite an incredible move in US rates, it is quite difficult to describe henceI'll let a chart tell the story...
US 10 year yield
We saw a huge move, probably the largest (once adjusted for yield) ever. Nearly everyone I've spoken to since the move last Wednesday that sits on the sell-side said their rates desk got absolutely slaughtered. Especially given the exposures that rates desks can take on, a 3% move in a currency is big... but a 3% move in the price of the US 10 year note is massive - and it hurt a lot of people.

The craziest thing is, that we ended the week only marginally lower from where we opened.

USD 1y1y
The forwards and especially the short end got hit lower and have stayed down, 1y1y has dropped by over 50bps and the expectations of rate hikes from the Fed have been really pushed back... Using Eurodollar futures we can see that the market had pretty much agreed on July 2015. However, one day the market in its infinite wisdom just decided to push that back to November!

CS 1st hike date

However it wasn't just US rates that went a bit crazy, we saw a large move in Peripheral rates too! Italian 2y's also had a busy day on Thursday with yields doubling in a few minutes!

However this does present us with some trade ideas, firstly and simply with the USD. The big event next week is clearly the FOMC statement where we will finally see Yellen's actions. The move in rates must have something to do with how people are perceiving Yellen, however it is still very likely that the QE program will finish, but any discussion about "considerable time" are out of the question it seems.

Currently, it seems after the recent rates move the EURUSD is trading fairly cheap to 2 year spreads, and its perfectly feesible to see a pickup towards 1.300 in the coming weeks.

We've still got extreme positioning, and the USD does seem overextended still (even at 1.28) as I was quoted saying here (

We were trading around 1.26 then, and I stick with my price target towards 1.30.

One way the Fed could push back expectations is by lowering NAIRU forecasts, possibly to below 5% to buy some time for Yellen to push back rate hikes. This will of course weaken the USD, but I think the bigger question is the disinflation we've seen in 2014 (particularly last few months in 5y5y inflation swaps) a problem for monetary policy? 

I mean, there may be demand issues but given the move in inflation is global and we've seen a large drop in oil/commodity prices, its clear to me that oil prices are in fact impacting monetary policy, or at least market expectations of policy.

This scatter from @boes and @ericbeebo is particularly interesting as it does show the strong relationship between the two.

And assuming that Yellen leans on the dovish side, its a conveniently timed excuse to be even more dovish!

As such I think that Cable offers decent upside along with EURUSD. As we can see from the chart, the 1y1y spread is still important for the pair and this will most certainly continue going forward, but assuming we see some further short term weakness in US yields from a dovish yellen then the USD will weaken and the GBP is already marginally cheap (and heavily shorted).

All in all, we've seen a monster move in rates, and a complete shift in sentiment regarding 2015 and the Fed, however from what I see, its only a transitory thing due to oil/commodity price declines and as such I once again am looking to pay rates, short Eurodollars and buy the USD - just at better prices.

*sorry its a short and quick one with very little detail but I crammed it in (got to study... or something). I will try to write some more / better posts in the future

1 comment:

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