At 8:30 am on Friday morning the investment world finally got the answer to the question it had been asking for years. When exactly will the US raise the Fed Fund rate (for the first time since 2006)? The market seems pretty sure it will be December 16th, at their last FOMC meeting of the year. I don’t trade credit or currencies, and monetary policy is way above my pay-grade, but the move higher in the dollar and in treasury yields the last two weeks speaks to the fact that there has been a meaningful shift in expectations and will now take some sort of unexpected external event to get the Fed to balk again.
It’s interesting to take a quick look back the recent history of market expectations for the Fed (first to end QE and now to end ZIRP). Remember back in May 2013 when the Fed floated the trial balloon that they would taper their bond purchases, and integral part of QE? The 5 year chart of the 10 year Treasury Yield below shows what is now an interesting double top in yields at 3% in the second half of 2013 as the market priced the wind down of QE:
Prior to Friday’s better than expected October Jobs report there was a lot of talk of one and done on the rate increase front, that any move would be symbolic. If we do get a tightening with a balanced statement I am hard-pressed to see rates run too far too fast, given external factors that are again, way above my pay-grade. But for those of you who don’t like to fight trends, the 30 year downtrend in Treasury yields appears to be structural as opposed to cyclical:
So for those who made a lot of dough in the last 6 years not Fighting the Fed, it may make sense to stay the course. In May of this year, the 20 Year Treasury Bond etf, the TLT, broke the uptrend that had been in place from the double bottom low in bond prices in the second half of 2013 (which was highlighted above in yield terms) and saw a precipitous drop to long term support at $115, and then saw a sharp rally back in late August and then failed right where it should of on a massive spike, at the uptrend. Rather than look to reverse 30 years of history, the better trade could be to wait for a re-test $115, and look for a continuation of the downtrend in yields.
With 30 day at the money implied vol back below 12%, options prices seem reasonable for those looking to express directional views in the TLT, but they could continue to grind lower for the next month into the EXPECTED rate increase. Selling short dated calls, to buy longer dated ones could be the way to play (we will update this trade view in a separate post):