EDM5-EDU5 spread: 23.5 basis points separate EDM5 and EDU5. We looked at this spread a few weeks ago at 20 bps and still think it is rather tight even here for the prospects of better growth and a push forward for the Fed to initiate a move from the zero bound.
This spread would benefit from either an earlier expectation for a Fed move or an expectation that the glide path for policy rates will be a steeper ascent that currently widely envisioned. The first concern is usually the lift-off date, but following close behind would be the prospects for a quicker move to the neutral rate. Even if that policy neutral rate is lower than in prior tightening cycles, an expectation that the Fed will want to move to there quicker would push this spread wider. The Fed’s expectation for the longer-run or equilibrium policy rate is 3.75% and some expect even this will move lower over time.
However, 23 basis points in not a lot of Fed work and there is room for the EDM5-EDU5 calendar spread to move out to over the next couple months. There is roll-up risk and one should pay close attention to any position should the spread move back toward 18-19.