Bond Traders Flood Into Hawkish Fed Bets After Strong Job Report
(Bloomberg) -- Bond traders are rushing into wagers that the Federal Reserve will continue to raise interest rates well into next year after Friday’s jobs report showed the strongest wage gains since 2009.
While the eurodollar futures, fed fund futures and overnight index swap markets have almost fully priced in the Fed’s forecast of three hikes this year, they’ve been, until recently, stubbornly dovish on the pace of rate increases beyond 2018. Not anymore. Demand in the eurodollar market has surged for downside hedges -- or protection against a more aggressive policy path -- across the 2019 and 2020 tenors as the backdrop of a weaker dollar, tax cuts and rising wages fuels expectations inflation is on the upswing.
The spread between December 2018 and 2019 contracts climbed to 37.5 basis points Friday -- suggesting traders are now pricing in about one-and-a-half hikes next year -- as the strip continues to aggressively bear steepen. It comes after a flurry of trades immediately following Wednesday’s Fed meeting also betting on front-end spreads to widen further. The gap between December-18 and December-19 contracts has more than doubled since the start of the year.
Nonfarm payrolls rose 200,000 in January, exceeding the median estimate of economists for a 180,000 increase. Average hourly earnings rose 2.9 percent from a year earlier, the most since June 2009. Subtle tweaks in the language of this week’s Fed policy statement may also be fueling the wagers, according to Goldman Sachs Group Inc. Chief Economist Jan Hatzius.
“While further rate increases were already implied by the previous wording – and by the hikes projected in the December summary of economic projections – we think the committee implemented this change to emphasize the durability of the hiking cycle they foresee,” Hatzius wrote in a Wednesday note to clients.
Other strategists are now warning of an upward revision to the Fed’s longer-term rate forecasts next month. In addition to three 0.25 percentage point rate increases in 2018, policy makers predict just over two in 2019 and about one-and-a-half hikes in 2020, according to the Federal Open Market Committee’s dot-plot projections.
The steepening move in the eurodollar market is matched by a 22 percent climb in open interest in December-18 futures and a 39 percent rise in December-19 futures since the start of the year. Friday saw volume on spread trades between the two surge to the highest on record. In the options space, new hawkish bets are being lined up for 2019, while existing downside hedges are increasingly being pushed further out the eurodollar strip.
Traders are wagering the strip will continue its post-FOMC bear steepening, with the red (2019), green (2020) and blue (2021) packs significantly underperforming the front-end white packs.
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