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Strategies & Market Trends : The Epic American Credit and Bond Bubble Laboratory -- Ignore unavailable to you. Want to Upgrade?

To: loantech who wrote (1574)	10/18/2003 10:24:42 PM
From: mishedlo	Respond to of 110194

I received this post from Mr. Plunger on my board on the FOOL. This helps me and hopefully you and Haim as well. Here goes: ================================================== Mish, I read this Mauldin piece and was initially very excited, but like GATA, he doesn't have any evidence whatsoever for his statements. And whilst he says that any sane person wouldn't expect the Fed to raise rates until 2005, note that Bear Stearns house view is for a hike in Mar 04, and Goldman has brought their view in from Late 05 to 04 because of the current riproaring growth. My view is the Roach one that the current burst of stimulus-driven activity will be shortlived - but it might cause the market to backup bond yields more before it is done. OK Eurodollars. And you'll see that Mauldin doesn't accurately understand these himself, another disappointment in his essay. First the Fed Funds rate is that at which banks lend money to each other overnight. The Fed sets a target and offers to buy and sell any amount of treasury bills at a discount rate that supplies enough liquidity to stabilise the overnight market at the target Fed Funds price. The Fed Funds future is a bet on the average Fed Funds rate for the month. So, Mar 04 is trading at 98.885. Given that 99.00 would mean 1% rates and 98.75 would be 1.25% then 98.885 means a 54% chance of 1% through the month, and a 46% chance of 1.25%. But actually there is an FOMC meeting on Mar 16th, so if the first half of the month has 1% Fed Funds, there is a 92% chance of the meeting hiking ... according to the market. Implied yields on fed funds futures are Feb 04 1.055% Mar 04 1.115% Apr 04 1.195% May 04 1.325% Jun 04 1.355% Jul 04 1.525% Aug 04 1.680% And that's as far as they go. So as Mauldin says we look at the Eurodollars from there. But these are different. They are a bet on USD Libor (London Interbank Offered Rate) at the settlement date, the third Monday of the contract month. So it's not Fed Funds, and it's not an average rate. What difference does this make? First, banks require about a 1/8% spread and so in a flat rate environment Libor trades roughtly 12 bp higher than Fed Funds. Secondly the contratcs are for 3-month Libor and so represent 12 bp more than the market estimate of average fed Funds over the period. If we simplify and say this means over the Fed Funds rate at the middle of those 3 months, we get the following table from Eurodollar contracts EDZ3 Dec 03 98.785 implies Fed Funds on 01 Feb 04 of 1.095% EDH4 Mar 04 98.575 implies Fed Funds on 01 May 04 of 1.305% EDM4 Jun 04 98.240 implies Fed Funds on 01 Aug 04 of 1.640% EDU4 Sep 04 97.840 implies Fed Funds on 01 Nov 04 of 2.040% EDZ4 Dec 04 97.385 implies Fed Funds on 01 Feb 05 of 2.495% EDH5 Mar 05 96.975 implies Fed Funds on 01 May 05 of 2.905% EDM5 Jun 05 96.620 implies Fed Funds on 01 Aug 05 of 3.260% So the important point in my view is the EDU4 implying now over 2% Fed Funds at the Presidential Election. The point is that not only would this mop up liquidity but if fed Funds went there, the 10Y might be at 6% and there would have been no refis at all between now and then. Plus, banks' fixed income desks that have been the recent source of gravy would be starved, and the automakers might need to start charging for loans. I do buy into the idea that the economy is only supported by ever more debt, and so this simply can't happen ... unless Bush really kicks in the turbo next year to replace all private sector debt with federal debt. We would be talking deficits of 20% of GDP not just 6% for that IMO ... which would be mighty good for gold if not Treasuries. Myself I own some EDM5 at this point, betting on rates lower than 3.26% mid 2005 because I don't think the "The economic framework doesn't work in our favor so let's smash it up it" political wave will manage to run that far with people like Krugman on the case and alerting the public. Plunger.