TALK FROM THE TRENCHES: FOMC OPTIONS, POSSIBLE MKT REACTIONS
economeister.com
By Isobel Kennedy
NEW YORK (MktNews) - U.S. Treasuries are slightly softer across the curve Monday as last-minute position squaring takes place ahead of tomorrow's FOMC meeting.
The importance of this meeting cannot be underestimated. One source says the "FOMC opens Tuesday at 1100 Theaters Nationwide." Another says it is the "Rosetta Stone of the markets for the rest of 1999 and the start of Y2K."
A MNI survey of 23 economists shows 14 respondents looking for a 25 bps rate hike while nine say the Fed will stay on hold. Of those looking for a rate increase, all say the Fed will then move to a neutral bias. All of the nine respondents who say the Fed will refrain from a move tomorrow believe the Fed will keep its tightening bias.
Possible reaction to a 25 bps hike and move to neutral bias: Market rallies initially and there is a small flattening of the curve led by the back end. However, upside momentum would be capped because a "buy the rumor, sell the fact" scenario would subsequently steepen out the curve over the following sessions. Given the recent dramatic flattening of the U.S. curve, strategists look for Treasuries to mimic the steepening of EMU curves following the ECB and UK rate hikes.
Expected reaction to no rate hike but maintenance of a tightening bias: Given the current flat yield curve, a decent probability of a tightening is already priced in and that means the short end has potential to do better into year-end since no further move from the Fed are expected until 2000. Since Street positions are believed to be flat, traders cannot sit with neutral positions ahead of year-end. They may look to get long in anticipation of all that cash money managers have to put to work before the New Year. Prices should initially rally led by the front end and the curve should steepen. And some think long bonds may actually get hit on thoughts the Fed was "behind the inflation fighting curve".
Is there a chance the Fed does not raise rates and moves back to a neutral bias? Very unlikely -- but if they do, one strategist says they run the risk of spurring growth before the economy has a chance to truly slow down because the stock and bond markets would rally further. Some things the Fed must watch out for, he says, are: 1) Global stock rallies are creating more wealth and lower capital costs which are boosting worldwide growth; 2) Commodity prices are still rising; 3) Consumer confidence is up and that will spur spending during the holidays; 4) Pipeline inflation pressures are emerging.
What if the Fed raised rates and left a tightening bias in place? This is also unlikely but if it happened, all bets are off, sources say. And there are some who are even calling for an inverted yield curve by Q1 2000 in this instance.
In addition to any actual rate/bias moves, players will also watch for any statement coming from the FOMC. But sources say given the recent turnaround in market sentiment, most will try to attach a bullish spin to it anyway.
Well in just about 24 hours, the market will have its answer. And whatever the Fed decides tomorrow is likely to be the decision the market operates under until 2000. Rightly or wrongly, tomorrow is viewed by many as the last chance the Fed has to act before Y2K becomes a reality. Because they will be supplying massive liquidity into the market for year end, it is unlikely they would make any rate moves at the December and January meetings.
The Fed, too, knows there are lots of economic numbers due out before their February 2000 meeting. One biggie, the consumer price index, comes out this Wednesday. Sources say they will want to make a decision that covers their bases for a long time. They don't want the markets to think they are behind the curve.
Speaking of the curve, the 2/30Y curve was last at 25 Bps vs 26 Bps on Friday. The +26 level is the tightest spread since the spring of 1998. Senior market strategist says the 2/30Y spread has support at 15 Bps while others look for additional flattening to about 12 Bps, a double bottom from 1998 and late 1994. They say substantial corporate redemptions, Treasury coupon payments, tighter swap and agency spreads bode well for longer paper and a flatter yield curve.
Update on European Rates: Bundesbank President and ECB Governing Council member Ernst Welteke said Monday that he agreed with ECB Vice President Christian Noyer who said last week that ECB monetary policy is still "accommodative" despite the 50 basis point rate hike Nov. 4. Welteke also repeated the well-worn metaphor used by ECB President Wim Duisenberg to describe the rate hike -- the central bank had simply taken its foot off the gas rather than stepped on the brakes.
Update on emerging markets: The sector continues to rally with spreads tighter because there are no "red flags" in sight. Last week, it was good news out of Ecuador as a deal with the IMF was hopeful. Russia hopes for some progress on debt agreement. S&P upgraded Korea and Malaysia, and changed its outlook for Brazil from stable to positive. Analysts say even a rate hike by the Fed should be taken in stride, as like Europe, the outlook for any additional policy change is way down the road. --Robert Ramos and Kim Rellahan contributed
NOTE: Talk From the Trenches is a daily compendium of chatter from Treasury trading rooms offered as a gauge of the mood in the financial markets. It is not hard, verified news. |
