Bonds sneeze and the yield curve catches a cold

Yesterday we noted how December was the strongest ADP reading for employment creation since November 2012 in the latest sign of labor market acceleration. There was little to blindside traders in the release of the December FOMC minutes Wednesday afternoon, which showed “many” of the committee in favor of only gradual reduction in the pace of bond purchases. Benchmark Treasury yields at the 10-year horizon (CBOT:ZNH14) are little changed, up by 5.5 basis points yet remain below 3.00%. Many expect an improving economy to herald a spike in Treasury yields for 2014.    

Short-dated three-month Eurodollar futures contracts showed quite a nasty reaction to the ADP report with traders seemingly positioning ahead of the official government report due for release Friday. While the 238,000 jobs reported by ADP does not guarantee a big number from the BLS, investors are starting to figure that just maybe the economy is advancing better than they had thought. The December 2016 expiration Eurodollar futures contract lost 16bps in response to firmer economic data sending its implied yield higher by such an amount. Implied yields for 2015 expirations rose by 10bs, while those expiring 2017 tacked in 12bps as of the close of trading on Wednesday ahead of Friday’s key nonfarm payroll reading. The dash out of Eurodollar contracts signals concern, rightly or wrongly, that the FOMC will speed up its return to monetary tightening even if it does not accelerate the tapering process.

Chart – Eurodollar futures slammed as employment gains traction

As noted, investors tend to act on information received and tend to ask questions later. The shift in implied yields resulting from the downdraft in futures contracts has probably gathered steam as a result of liquidation and/or the perceived notion that bigger investment houses carrying a lot of clout are having a positional rethink about the Fed.  

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