I know I've been making a big deal of this of late, but it dawned on me that many here might not understand how backwardization or carrying cost works, and thus may be thinking I'm saying rates can go down? That's not correct. The easiest way to illustrate this is with the Eurodollar (*)(ED) since it's quoted in a manner where you can calculate yield.
If we took the one I'm toying with, the Sept ED, it's trading about 96.10. It matures on Sept.19, so in effect the market thinks ED yields at that date will be 3.90%. Right now the March ED going off (on 3/21) are at 3.03%. So effectively the market has already priced in 87 bps of higher rates between the next meeting on 3/22 and 9/20. The Fed meets again 5/3, 6/30, 8/9, and 9/20. This is a rough way to evaluate this, but without getting too anal, the market is already factoring in 3 and a half more rate increases for those four dates. Including 3/22, it's 4 and half of the next five meetings.
Looking at the Dec ED, it's priced at 4.16%, and with the Fed mettings on 11/1, and 12/13, the market is currently pricing in one pause in that period.
So it appears the commercials are saying it won't happen that way. If it's only 4, they make 12 bps in theory. If it's only three increases they make 37. My SWAG on why the commercials are making such a big bet? They only expect the Fed Funds to go to 3.25% through 9/20, with two pauses in there. So rates are going higher, just not as much as the market thinks at present. I think by inference, one could also assume an economic slowdown of some sorts will also be underway if 3.25 or lower is the number.
(*) Eurodollar : A U.S. dollar deposited in a bank outside the United States. |
