Money market strategists spent most of their commentaries last week writing about Janet Yellen and the Federal Reserve's seeming shift towards raising the Fed funds target rate earlier in 2015 than many expected. We quote below from several of them. Barclays latest "US Weekly Money Market Update", written by Joe Abate, says, "Short-term (as well as other fixed income) markets were riled by the increase in the FOMC's median fed funds forecasts for 2015 and 2016 that accompanied the FOMC statement. The median estimate for 2015 increased from 0.75% to 1.00%, and the estimate for 2016 rose to 2.25% from 1.75%. Markets got a further shock later during the press conference when Fed Chair Yellen implied that the Fed could raise interest rates perhaps "six months or that type of thing" after the asset purchases ended. Since there is a nearly uniform consensus that the Fed's asset purchases will end in October, her six-month comment suggested that the Fed might consider pushing interest rates higher as soon as March or April 2015. This is considerably sooner than the markets were pricing in before the FOMC meeting."
Abate continues, "Indeed, the implied yields on the December 2015 and December 2016 fed funds futures contracts moved higher by 18 and 29bp, respectively, between Tuesday and Thursday. Similarly, the June 2015 fed funds contract sold off by 7.5bp as markets moved the timing of the first rate hike from the fall to late spring 2015. But have markets overreacted a bit? We think that they may be reading too much into the Fed's dots."
J.P. Morgan Securities' weekly "Short-Term Fixed Income", written by Alex Roever and Teresa Ho, comments, "All eyes were on the Fed this week, as Janet Yellen conducted her first FOMC meeting and news conference as Fed chairwoman. While there were parts of the meeting/news conference that came in closer to expectations, there were other parts that surprised the markets as well. Overall, the balance of information provided a more hawkish tone than anticipated."
They explain, "As expected, the Fed announced that it would taper another $10bn, reducing its asset purchases to $55bn per month ($25bn in MBS and $30bn in Treasuries) effective in April. At the current pace of decline, this would suggest that the Fed will draw its asset purchase program to a close by the end of October. Furthermore, the FOMC moved toward a more qualitative forward guidance, by jettisoning the numeric thresholds which had been a key part of policy statements since December 2012. Instead, the FOMC will take into account a wide assortment of labor market, inflation and financial market indicators when deciding to remove policy accommodation."
JPM writes, "Away from tapering and forward guidance, one of the key developments that decidedly delivered a more hawkish flavor to the meeting was its interest rate forecast. Based on the Fed's Summary of Economic Projections (SEP), there are now 13 participants that expect the first tightening to occur in 2015, up from 12 in the previous December projections, and two participants that expect the first rate hike to occur in 2016, down from three previously. More significantly, the median Fed Funds target forecast for 4Q15 increased 25bp to 1.0% and for 4Q16 50bp to 2.25%. As our US economist noted, the change in the Fed Funds forecast is greater than that would be implied by the change in economic forecast and thus suggests a relatively hawkish shift in the Fed's reaction function. This perception was reinforced by Yellen's remark, perhaps inadvertently, that rate hikes could commence six months after the end of asset purchases, which would imply Q215. Prior to the Fed meeting, the Fed Funds futures market was pricing Q415."
They add, "Against this backdrop, the liquidity markets generally remained well behaved. Although Treasury bill yields trended higher immediately after the release of the FOMC statement, the trend appeared to have dissipated by Thursday's morning as yields fell. Outside of bills, GC repo yields moved lower as we began to see the stock of bill outstandings decline as we near the end of tax season. GC repo finished the week at 7bp, and assuming we see no announcement to an increase to the Fed's RRP rate or the deposit rate paid to FMUs that have access to the Fed, we wouldn't be surprised if GC trades tight to the Fed's RRP rate in the coming weeks."
Wells Fargo's Garret Sloan comments on the overall higher rates recently, "The repo market has been strangely elevated for the entire month of March and it feels like that stickiness in the high single digit rates and at some points in the low double digits has potentially aroused the rest of the market. Despite the fact that much of the collateral glut in the repo markets took place earlier in February, it was not until month-end that we saw a real backup in rates. Until that point 5 basis points was the norm, but a combination of things seems to have caught up with repo and it may be contagious. The last day of February, repo jumped higher from 5 basis points to just under 10 basis points, and it has not looked back. It initially felt like it would be a temporary situation, but repo rates have held: possibly helped by a higher reverse repo rate and a higher maximum allocation that changed on February 25th.
Finally, he adds, "Perhaps this could be the turn of the tide in the front-end as investors begin to push back on low rates and tight spreads. It will be interesting to see who prevails in this clash of wills. The 1-month offered side in 30-day top tier CP backed up 2 basis points yesterday while tier 2 CP on average remained flat. But with repo in the high single digits, the interest in mid-single digit industrial CP of course should decline, and if not decline at least investors will push back simply out of indignation at the thought of paying up for 30-day industrial CP relative to Treasury repo."
