FxWirePro: Preview Of FOMC And Trade Perspectives On Rates

The markets today is cautiously observing on tonight’s FOMC meeting. No major policy changes are expected though, we do get a return of ‘forward guidance’, with the ‘dot plot’ expected to highlight policy won’t be tightened for a considerable period of time – the last thing they need is a taper type tantrum. 

For the first time in six months the Fed will be publishing economic forecasts again today. It had refrained from doing so following the outbreak of the corona crisis and the high uncertainty resulting from this.

The market is discussing the Fed implementing yield curve control, but less likely this will be announced today. We should also get an update to their economic projections (suspended in March). Especially, the FX market will no doubt be very interested in the forecasts that is expected to come out as either they will confirm its expectation of a rapid recovery, which had fuelled the risk-on rally of the past weeks, or they will sew doubts about it. Considerations or even the announcement of further expansionary measures on the other hand will be of secondary importance for the exchange rates, as the central bankers have reached the end of the line as far as the key rate, i.e. the FX relevant tool, is concerned. Even if the Fed decided to enter negative territory – which most FOMC members seem to have rejected so far – its scope would be limited. Of course, it is impossible to tell with certainty where exactly the lower limit for interest rates would be located.

However, the likelihood is high that it is not much below the levels already tried by other central banks. As a result the lower level in interest rates might be just under 1% below current levels. In view of the current exchange rate volatility that is not really worth mentioning.

There was anyhow much more of a debate most recently about the introduction of a yield curve control strategy à la Japan. The BoJ defines a target for the yield of 10-year JGBs (currently 0% +/- 0.2 percentage points). Its asset purchases are aimed at stabilising yields at these levels. Some FOMC members seem to have taken a shine to this approach.

However, we should understand that this step cannot necessarily be interpreted as being dovish. Of course the central bank anchors yields much more effectively at low levels than would be possible with forward guidance (the promise to keep interest rates at low levels). With forward guidance yields can still fluctuate heavily depending on the market’s outlook on the economy. 

US 2yr treasury yields slipped from 0.22% to 0.20%, while the 10yr yield fell from 0.85% to 0.80%.

Trade tips: 

Buy 6Mx(5s/30s) conditional bull steepeners.

Many treasury strategists anticipate a steeper curve amidst rising supply, and market microstructure points to more stable vols that supports selling top right gamma.

Buy $100mn 6Mx5Y ATMF receivers (notification:12/6/20,maturity:12/9/25, strike: 0.6%) at 75c versus selling $13mn of 6Mx30Y ATMF receivers (notification: 12/6/20, maturity: 12/9/50, strike: 1.28%) at 590c.

Sell 2Yx30Y vs 5Yx30Y ATMF vega-neutral straddles.

Taiwanese life insurance demand for callables appears to be slowing, and moving into a quitter issuance period, this likely spells lower vega supply.

Sell $25mn 2Yx30Y ATMF straddles (notification:6/6/22,maturity:6/8/52, strike: 1.33) at 2078c versus buying 5Yx30Y ATMF straddles (notification: 6/6/25, maturity: 6/10/55, strike: 1.4) at 2840c. This trade requires frequent delta hedging. Courtesy: JPM & Commerzbank