All,
The real OCTANE inside the bull....no rate hike for 1997?
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Thursday July 3 1:33 PM EDT
U.S. YIELD CURVE -- Fed seen on hold indefinitely
By Steven Scheer
NEW YORK, July 3 (Reuter) - It's official. The U.S. Treasury market does not believe the Federal Reserve will raise rates in August, perhaps not for the rest of the year.
Need proof? The spread between the federal funds rate -- currently at 5.50 percent -- and the two-year note has narrowed to its lowest point since just after Thanksgiving.
The two-year note's yield dove to 5.93 percent Friday morning from 6.02 percent late Thursday. That put the funds -twos spread at 43 basis points, the narrowest since December 4, 1996.
The two-year note's yield dove to 5.93 percent Thursday morning from 6.02 percent late Wednesday.
That put the funds -twos spread at 43 basis points, the narrowest since December 4, 1996.
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The market had not ruled out a Fed tightening in August until Thursday's weaker-than-expected June
employment report appeared to sharply reduce chances that the Fed would boost rates for the rest
of this year.
``At this point, there is no tightening discounted in the market for the foreseeable future,'' said Tom Macirowski, Treasury strategist at Goldman, Sachs & Co Inc.
Traditionally, a spread of 50 basis points between the two rates means the Fed is on hold. A spread
significantly below 50 indicates the market anticipates an ease as the next Fed move.
Analysts said the spread relationship between funds and twos has changed in recent months, thanks to the Treasury. Therefore, it may be that instead of a twos-funds spread of 50 basis points suggesting a neutral Fed, it is now 40 basis points.
Over the past two years, the Treasury has cut the size of monthly two-year note issuance by about
$3.0 billion, falling to just $15.5 billion at the last auction.
The lower supply has driven up two-year prices.
``There's nothing to be alarmed about just because two-year notes are (43) basis points over funds,''
said Jim Caron, an options trader at Sanwa Securities (USA) Co. ``It doesn't mean the Fed is going
to ease at the next meeting.''
Caron said the spread between twos and funds can be looked at as an option premium, reflecting a probability of a Fed move in the future. Since the market is at historically low volatility, ``It only makes
sense that premiums would be smaller and therefore the spread between twos and funds would be smaller,'' he said.
Meanwhile, some said the two-year note was becoming a replacement for investing at the repo rate.
``Instead of putting money with a dealer and getting paid 5.50 percent, people are buying two-year notes,'' said Craig Coats, co-head of taxable fixed income at Prudential Securities Inc. ``They don't
mind the two-year exposure and earning 40 to 50 basis points of carry.''
Traders, however, said that the two-year note would likely hit a wall at about 5.90 percent, which would force investors to move out along the curve. Consequently, traders expect other spreads to flatten by five to 10 basis points, starting as early as Thursday afternoon and early next week.
Yet, it will still be the fundamentals that will ultimately determine spreads, most agreed, and the market will keep an eye on upcoming retail sales and inflation reports.
``Right now, these will not be challenging sets of data,'' Flanagan said. ``And that is why the market is trading as it is.''
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Ibexx
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