A Fed grand plan?

March 19, 2015 03:34 PM

Yesterday’s FOMC announcements drove Eurodollar and Treasury prices a magnitude beyond the usual post-FOMC meeting response. We noted yesterday the 15+ basis point response in 10-year Treasuries and the 25+ bp advance in some of the back month Eurodollar contracts as indicative of a lack of Fed transparency in their communications.

Maybe it was the more than 5% advance in the dollar index since the start of the month that staggered Fed officials and encouraged them to adjust their assessments in the days before announcement, leaving them unable to transmit that information to market participants because of the unofficial ‘black-out’ period of a week before the meeting. This or some similar newly discovered information would account for the lack of transparency.

Otherwise, what is to be assumed other than the Fed intended to surprise the market participants with a more dovish than expected statement, Survey of Economic Projections (SEP) and post-meeting press conference?

I have suggested that until the Fed moves clearly from an overly accommodative policy directive to a directive that is removing that accommodation, there is room for heightened volatility even without Fed surprises such as yesterday adding to such. Even without the Fed clearly articulating a policy path for the fed funds policy rate, economic agents act with more confidence knowing which ‘regime’ the Fed is operating within. The middle ground between easy and firming policy regime is volatile ground and not supportive of economic growth.

The nearest to expiry contract, June 2015 Eurodollar contracts, rallied 4.5 bps (open to close) yesterday, which was dwarfed by the move in the back month Eurodollars that flattened the front to Green Eurodollars by 15 bps. Still when we consider that for the nearest to expiry Eurodollar during the last 5 years the median daily range has been 1 basis point, it is not as surprising to note that the last time the contract closed 4.5 bps higher than open was back in November 2011.

Yesterday was truly an outsized move, not terribly unlike the post January employment sell-off that resulted in a similarly outsized decline in the 5th quarterly contract. That decline was not reversed as much then as was today’s trade reversed yesterday’s advance. The interest I have in this exam is that in theory, a significant price move that has ‘lasting’ influence on price action going forward tends not to relinquish much of its initial single session gains. In the absence of that ability to hold gains, we suspect that there is not the lasting power in the move and that the ground gained will be relinquished.

Food for thought: A Fed announcement that would ‘rein in’ the bulls as greatly as it had just reined in the bears following yesterday’s post-FOMC announcement would be a 50 basis point hike at the June 2015 meeting. Even the score and let all know (Congress included) who is in charge. Consider the statements from then Governor Ben Bernanke on Oct. 7, 2004 in a speech on Central Bank Talk and Monetary Policy.

He said: “Beyond the basic rationales of democratic accountability and engagement with the public, however, open and clear communication by the policy committee--which in practice includes speeches and congressional testimony by FOMC members, as well as official statements--makes monetary policy more effective in at least three distinct ways."

First, in the very short run, clear communication helps to increase the near-term predictability of FOMC rate decisions, which reduces risk and volatility in financial markets and allows for smoother adjustment of the economy to rate changes.


About the Author

Martin McGuire, managing director at TJM Institutional Services