Comfortable with higher rates and higher oil
–Interest rate markets remain very quiet, with the ten year auction going off just under 3%. The short end continues to be weak, with new highs in a few near calendar spreads. For example, EDM8/EDM9 one-yr spread closed 52.0, +2.5 on the day, with EDU8/9 45.5, +2.0. Both are new high settles. The peak 3 month spread is Sept/Dec which closed 16.5. Staying with the short end, note that some FF contracts made new lows. For example, FFF9 (January) closed at a new low of 9771.5. With the current Fed effective 1.70, July FF at 9805.5 (1.945) is fully pricing June’s hike. If we assume a new Fed eff of 1.95, then two more hikes into year end would be 2.45, vs Jan FF of 2.285. Aug/Oct FF calendar isolates the Sept FOMC; the spread settled 18 so approx 75% chance of a hike at that meeting, while, Nov/Jan closed 12.5, so 50% for the Dec meeting.
–CPI expected 0.3 with Core 0.2, (yoy 2.5 and 2.2), but interest rate markets now apparently feel comfortable with a small overshoot of the Fed’s target, given that hike odds are aggressively priced. Thirty year auction today with w/i 316/315 at futures close. The thirty year bond is only giving a yield advantage of 5/8% over the two year note; not much there in terms of ‘inflation premium’.
–Energy stocks like the high oil prices. I guess the rest of the market is satisfied (looking at greens and blues of the euro$ curve which suggest a terminal FF rate of 3% or lower) that gradual rate hikes can be absorbed. After all, in 1993, 3% WAS the emergency low funding rate.
