Eurodollar reflects scant Fed policy change

Reuters News
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Posted: Mar 19, 2012 3:09 PM
Eurodollar reflects scant Fed policy change

By Ellen Freilich

NEW YORK (Reuters) - The apparent unwinding of some expectations for another imminent round of Federal Reserve quantitative monetary easing sent Treasury yields higher last week, yet this dynamic was less evident in the Eurodollar forward curve for interest rates.

Signs of improvement in the economy have made economists rethink how aggressive the Fed needs to be in monetary stimulus and led some to see chances the bank could raise interest rates sooner rather than later.

That Eurodollar futures contracts for 2014 -- when many analysts see a chance the Fed could raise rates -- do not reflect higher borrowing costs casts doubt on this prognosis for higher rates.

"Rising Treasury yields historically have signaled to Fed officials that their policy is off-base, but (have the affected Fed policy expectations been) embodied by the Eurodollar forward curve for interest rates? Not yet," said Chris Rupkey, managing director and chief financial economist at Bank of Tokyo-Mitsubishi UFJ in New York.

The forward curve of short-term interest rates, Eurodollar futures which trade at a spread above the Fed funds rate, had risen just 14 basis points to 1.435 percent as of Friday, for the December 2014 eurodollar futures contract.

It stood at 1.295 percent on January 24, 2012 when the Fed made its funds rate forecasts.

The Fed said following its January policy meeting that economic conditions are likely to warrant exceptionally low rates at least through late 2014.

At that time, six of 17 Federal Open Market Committee policymakers foresaw the Fed funds rate at 1.5 percent or higher at the end of 2014, six saw rates unchanged at 0.25 percent, and five thought the Fed funds rate will be 0.5 percent to 1.0 percent.

"Ten-year Treasuries would have to move up higher, probably above 2.75 percent to start affecting Fed expectations for the future path of the Fed funds target," he said.

The benchmark 10-year Treasury note yielded 2.35 percent on Monday.

Three-month Libor rates, meanwhile, were steady at the London fixing on Monday at 0.47365 percent, 22 basis points above a 0.25 percent Fed funds target.

Libor posted its first weekly rise in 2012 last week. The rate has fallen from over 0.58 percent at the beginning of the year, largely due to inexpensive three-year loans the European Central Bank has made available to the banking system.

The ECB loans bolstered bank funding levels and gave banks time to deal with risky sovereign debt holdings. Still, the three-month dollar Libor rate is higher than the 0.25 percent area where it traded in mid-2011, before concerns about European bank health intensified.

In sales of short-term debt, the Treasury sold $33 billion in 3-month bills at a high rate of 0.095 percent, awarding 2.64 percent of the bids at the high. It sold $31 billion in six-month bills at a high rate of 0.15 percent, awarding 41.27 percent of bids at the high.

The ratio of bids received over those accepted in the three-month bill sale was 4.30, the lowest since February 27. The ratio of bids received over those accepted in the six-month sale totaled 4.42 percent.

"Six-month auctions have been very steady in their performance and distribution," said Thomas Simons, money market economist at Jefferies & Co.

The Federal Home Loan Bank System sold $1.0 billion of two-year global notes due May 28, 2014 on Monday in a reopening of an existing 1.375 percent issue. The notes were priced at 101.981 yielding 0.478 percent. The ratio of bids received to those accepted was 2.6-to-1. The total amount now outstanding is $4.0 billion.

(Additional reporting by Caryn Trokie; Editing by Andrew Hay)