In Ominous Sign For Fed, Bond Traders Are Betting On Flatter Curve After Rate Hike

With the Fed Funds future market pricing in an almost certain 25 bps rate hike on March 15 following a series of hawkish comments by Fed officials this week, hitting 90% as of this morning, up threefold in the past week… 

…  with today’s 1pm speech by Janet Yellen expected to confirm the recent hawkish turn by the FOMC (a dovish statement could unleash chaos among the Eurodollar market, and result in a spike in volatility across other asset classes), an ominous trend was spoted in the longer-end of the yield curve, where as Bloomberg’s Tanvir Sudhu writes “those in the options market seem skeptical about higher longer-term interest rates.”

The reason: the difference in implied volatilities between payers and receivers on 10-year yields has turned negative from about eight basis points seen a week after Trump’s election, “suggesting increased demand to protect short bond positions. Flatter skews indicate receivers richening relative to payers, signaling expectations for lower rates.”

Meanwhile, as Sudhu adds, the one-month Treasury rate, two years forward, traditionally a proxy for the Fed’s terminal rate,  is as of this moment discounting six increases of 25 basis points each over the next two years and remains below the December highs. Still, the market remains just modestly behind the Fed: forwards are fully pricing in 62 basis points of increases by the end of the year, short of the 75 basis points indicated by Fed’s dot plot.

Here is the problem: as we showed yesterday, the TSY curve, especially the all important 5s30s, is already the flattest it has been at any moments since the financial crisis.

Factoring in 6 more rate hikes in the next two years suggest that absent a substantial pick up in inflation, the curve will invert, a traditional recessionary signal, just around the time of the 2018 midterm elections. To which, one may ask, if perhaps this has been the Fed’s intention ever since the Trump election? For now, the biggest beneficiaries of the Trump administration, the banks, are very much oblivious of such an eventuality.


Source: ZeroHedge