Generally, the Fed has a dual mandate: to promote maximum employment and keep a handle on inflation. Yellen herself has dedicated many speeches to the topic of employment. She has also always been very supportive of Bernanke’s push for increased transparency at the Fed, so we expect that trend to continue.
With Richard Fisher from Dallas and Charles Plosser of Philadelphia, the Fed has equipped a couple of vocal hawks with voting rights. However, President Obama’s recent nominations, including Stanley Fisher (Vice Chairman), along with Lael Brainard and Jerome Powell are believed to be doves.
The Federal Funds Target Rate (white line) has been pegged at 0.25% for the past five years. The 10-year note yield has also been steadily declining (pink line), reaching a low of 1.379% in July 2012. As the Fed began to hint at the possibility of tapering, the 10-year note yield reacted and began to rise in the spring of 2013. Ultimately, the pace of our ongoing economic recovery will dictate how soon the Fed will actually begin to raise rates. But, as mentioned before, based on the Fed’s own forecasts, tightening is expected to start in mid-2015.
Given this expectation, a good way to play this would be through the use of a spread, shorting the further out Eurodollar interest rate, March 2017, and going long the nearer-term March 2015 Eurodollar (see chart below).
Spread Chart: Long March 15’ Eurodollar/Short March 17’ Eurodollar
The long leg will serve as a safety net on a rally in nearby futures if yields actually drop. The current spread is near 2.00 full points and as rates start to move higher, we expect to see this spread trade near 3.00, which would represent a gain of $2,500. There is strong support at 1.60, which is where we would place our stop, so this position would have a 2:1 risk/reward ratio.