Looking past the ECB and unto the Fed

Market sentiment flip-flopped over the past two trading days. Disappointment on European Central Bank's (ECB) policy actions triggered a sharp selloff in UST and Eurozone sovereign bonds. Equity markets followed suit. By Friday, sentiment reversed. Nonfarm payrolls came in better than expected (actual: 211k, consensus: 200k) but this did not derail the bounce in equity markets. Moreover, USTs rallied even as the payroll numbers cemented expectations for Fed liftoff. 10Y UST yields are once again below 2.3%. 

Liftoff at next week's FOMC meeting is highly anticipated with the market putting the probability in excess of 70%. However, given that this would be the first time the Fed will be aiming to raise short-term rates in a decade and in a period of excess reserves, some volatility is to be expected. Moreover, the relationships of the various USD rates are uncertain under this new monetary policy mechanism. Previously, the Fed funds rate serves as a floor to USD market rates. However, the interest on excess reserves (IOER) and the reverse repo rate are supposed to fulfill this role. It remains to be seen how Libors and repo (government security) rates will trade relative to these new policy rates once liftoff occurs.