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Strategies & Market Trends : Three Amigos Stock Thread -- Ignore unavailable to you. Want to Upgrade?

To: Sergio H who wrote (15825)	6/13/1999 9:54:00 PM
From: j g cordes	Respond to of 29382

Here's the best discussion of rates I've seen this evening.. you may have to decrease or increase your font (I did -2X) to allow best viewing or go directly to the site via url at end. Analysis by Marc Chandler Written June 11, 1999 A tightening by the Federal Reserve at the end of the month is nearly a foregone conclusion. The terms of debate have shifted. At issue now is whether that quarter point hike is a one-off insurance policy or whether it is the start of a sequence to tightening steps. While bonds may be king, it is the money market rates that are most anchored to Fed funds, the overnight rate that the Fed directly influences by manipulating reserve conditions. Even the three month Eurodollar futures contract that many observers use can swing quite wildly for any given Fed funds level and, moreover, is not very useful in fine tuning expectations. It is difficult, for example, to use the September Eurodollar contract to determine whether the market expects a Fed hike in June, August or even October. There is a futures contract on the Fed funds. It is a cash-settled $5 mln notional value contract. The price is compared to the average effective Fed funds rate for the entire calendar month. The implied interest rate is determined by subtracting the price from 100. Since this month's meeting is the last day of the month, the July contract is more useful. At the time of this writing it was trading at 95.00. That would imply an effective average Fed funds rate of 5.00 (100-95.00). We know the current target is 4.75%. So the market has priced in 25 of a possible 25 basis point hike. The next meeting will be held on August 24. The September contract offers the cleanest read. It is currently trading around 94.80. That implies an average effective fund rates of 5.20%. One way of expressing this is to say that the market has priced in 20 of 25 basis points or about an 83% chance (20/25) of a second rate hike. The pendulum of market sentiment has swung too far. There is a sufficient amount of key economic data between meetings to cause the market to have second thoughts about its level of confidence of another tightening move. While a second step is possible, it is not nearly inevitable as the market currently seems to believe. The statement the FOMC issues following the June meeting will likely give the market greater guidance going forward than has often been the case. The Federal Reserve is committed to steps that will increase its transparency in a number of areas. That is partly why the tightening bias, announced at the last meeting, was so significant. Unlike in the past when a tightening bias meant little, under the new regime, it is part of the effort to prepare the market. The Federal Reserve is following the market after giving it the cue. Ironically, this tactic ensures a more volatile reaction if the Fed were to decide to stand pat. And provides a reasonable opportunity for the Fed's move (and subsequent statement) to stabilize the market. In addition, recent data suggests that the economy moderated in the second quarter from the heady pace in Q1. The monetary easing in the final third of last year and one-off factors like bonuses, early tax refunds, and another wave of refinancings, boosted growth in the first quarter. Consumption cannot be sustained at those levels, even with the modest pick up in incomes. While the evidence is mixed, it does appear that the interest rate sensitive sectors are beginning to feel the pinch of the sharp rise in interest rates. Net exports continue to act as a drag, even if there have been signs of stronger global growth. The market will be surely surprised if Q2 GDP comes in with a 2% handle. Nevertheless, the Fed is always looking ahead. The economy could accelerate again in Q3, perhaps as part of the inventory accumulation cycle. The hawks will argue that, given the momentum in the U.S. economy, the length of this expansion cycle, and what that does to expectations, it will take more than one quarter point rate hike to slow the U.S. economy. The Federal Reserve is also partly constrained by the Y2K issue. In particular, the demand for cash and fear of a crisis is already evident in the term structure. This extra uncertainty makes it unlikely that the Federal Reserve would change policy at its last meeting of the year, scheduled for December 21. Arguably, it is also desirable to avoid a change in policy at the meeting before that one, to be held in the middle of November. That essentially leaves the August and October meetings as the most likely candidates, should the Fed decide additional tightening measures are required. However, if the likely June hike can be a stabilizing influence in the financial markets, additional rate hikes might not be. The last time the Federal Reserve was engaged in a tightening operation was 1994. The dollar collapsed. The bond market suffered one of its worst years this century. The Dow essentially went no where, roughly confined to a 400 point trading range. While most of the crisis stricken areas are on the mend, the world economy still requires a strong U.S. economy and stable interest rate environment. Too aggressive of tightening would spook the market and potentially destabilize U.S. and world asset markets. Nor does the market perceive price pressures to be great enough to warrant repeat rate hikes. The markets are prone to overshooting, especially at potential turning points in the cycle. There is good reason to suspect that this is in part what is going on now. As the dust settles, we could be in for a healthy summer rally in bonds. However, it will take convincing evidence that U.S. growth continues to moderate to get 30 year bond yields back below 5.75%. On the upside, 6.12% is an important area that yields are unlikely to stay above. Some evidence that the Japanese and euro-zone economies are also bottoming will also put a floor under U.S. yields. dismal.com