Six Talking Points

1.  Many are arguing that the dollar’s rally reflects a shift in expectations of Fed policy.  There seems to be little evidence for this.  A shift in expectations would be most directly reflected in market pricing of the Fed funds futures and Eurodollar futures contracts.  Since the end of August, the implied yield of the March 2015 Fed funds futures contract has risen a single basis point to 15.5 bp.  The implied yield of the June 2015 Fed funds futures contract has risen by 3.5 bp to 30.5 bp.  We suspect that many observers are getting ahead of themselves by placing too much importance on comments from a few regional Fed presidents.  The recent JOLTS report gives little reason to expect a dramatic reassessment of the conditions of the labor market.  While the FOMC statement will evolve, it seems that there is still no urgency from the Fed’s leadership to change the forward guidance. 

2.  Economists and investors will agree that are many considerations that influence long-term interest rates, and Fed policy is only one of them.   The US 10-year yield rose from 2.34% at the end of August to nearly 2.55% yesterday.  The (generic) yield has risen every session this month.    One of the factors underpinning the yield may be the improved prospects for growth.   Barring the nonfarm payrolls and some consumption data, nearly every other major economic report has surprised the consensus to the upside.    That said, the 10-year yield has been held back by the 100-day moving average for the past five months.  Yesterday was the first day it finished above this average since April 3.   It is found today just below 2.53%.

3.   The widespread assumption is that the unorthodox easing by central banks has depressed volatility throughout the capital markets.  Some observers are trying to link the increase in volatility to a change in this, and specifically the Federal Reserve that will wind down QE next month.  There are two problems with this narrative.  First,  does not align with the rise in currency volatility that bottomed in mid-July.  The volatility of the S&P 500 (VIX) put in a recent peak in the first half of August, and currently sits on its 50-day moving average, below 13%.  Bond market volatility (MOVE) has risen.  It bottomed in early August.  Second, and more importantly, the global measures of liquidity are unlikely to change very much.  The liquidity that was emanating from the Federal Reserve will likely be replaced by the ECB beginning with next week’s TLTRO, and later supplemented by the ABS/covered bond purchase scheme.