Can zero rates in an inflationary environment foster destabilization?
May 28, 2021
–Front eurodollar futures are making new historic highs, with the June’21 contract settling 99.8825 or just 11.75 bps. The July and August contracts settled 99.885. Three month libor has been making a new low every day as the Fed’s RRP is flooded; yesterday’s operation totaled a record $485 billion. At the same time, stocks are near all time highs, and one article noted that Memorial Day gas prices are the highest in seven years. The Q1 GDP Price Index from yesterday’s data was 4.3%, a new high, though I only looked back to 2006. The zero-rate regime is almost certainly creating distortions that are unlikely to unwind gracefully. Yesterday’s price action featured a steeper curve, with tens up 3.4 bps to 1.608% and twos unchanged at just 14.5 bps. So 2/10 ended at 146.3, while the red/gold pack spread (2nd to 5th years on the euro$ curve) rose 3.25 bps to 158.5. Option trades favored the downside, with new put buying vs call selling occurring yesterday. There were also a few outright large futures sales, for example, 60k EDZ2 sold at 99.615 on a block. One hike before the end of next year puts this trade in the money; the contract settled 99.62 yesterday. Just 38 bps by the end of next year. I have a feeling the world will look very different by that time. Will USD continue to attract backers with yields this low against an increasingly inflationary backdrop? (Even if transitory). China yuan at a new high vs USD 6.365. The trade weighted dollar made a new low for the year but DXY has seen a small bounce in the past three days.
–Today’s news includes the Fed’s favorite inflation metric, PCE Core yoy Price, expected 2.9%.
