As it stands this morning, options market-implied odds of the Fed cutting by at least another 125bps by year-end are about 1 in 4. Since Wednesday’s close, the odds of the Fed cutting by at least another 75bps by year-end have roughly doubled. As it stands this morning, the Eurodollar options-implied odds (fitted to the FF curve & fwd FRA/OIS spreads) of a) the Fed only cutting once more by 25bps in September or, b) the Fed cutting rates by at least another 75bps are about equal.
Here are what the options market assign as the likeliest outcomes for the Fed this year (there are other possibilities, obviously – these are the most likely as defined by current options skew):
Last week played host to price action that was truly historic in the bigger picture. On Wednesday, both equities & gold sold off by more than 1% & the front-end of the Treasury curve sold off as well. That’s the first time ever the Fed has managed that on the same day as they’ve announced a cut in policy rates. Oh, and lest we forget, the dollar also strengthened on a trade-weighted basis.
Obviously, that front-end sell-off didn’t last long. In the long-term historical context, the 25bp+ rally we’ve seen in 2-year yields in the 3-day period AFTER the day of a Fed cut is not without precedent. But the last time since the start of the 1990s that we got a larger rally in absolute terms was in early 2001 – when yields were close to 5% (they followed that one up with another cut the same month, and then another 9 before the calendar year was up).
That’s all in the context of a trade “spat” that seems to be growing into a much larger conflagration. Despite the warnings of nearly every street economist that this will generate a significant inflationary impulse to consumers, over the next year, the market will charge you more to protect against inflation going below 0% than it will charge to protect you against inflation going above 2%. The last time this skew was so lopsided, the market was still expecting the Fed to hike rates this year.
It’s turning into a bit of a choppy affair today, so will update with some additional thoughts later in the afternoon.