(an interoffice email)

>
>
> 16bp day for 2yr spreads today:
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>
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> The market went into the fed announcement expecting perfection
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> 25-50bp cut and 50bps on the discount window.
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> Spreads were 6 lower on the day in the 2yr sprds and 3 lower in tens before
> the Fed.
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> Needless to say the market was disappointed…
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> Spreads moved back to the wides in the front end
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> and now are repricing an expectation of extended financial market /
> financing turmoil

Hi,

Looked to me like the post fed moves were unwinds of all sorts, and didn’t fit any other theme, so I’ll be watching for reversals after things settle down tomorrow am.

Interesting that the markets were shocked that the Fed cared about inflation. I read the speeches as saying they do care a lot, but the media glossed over those parts and didn’t even report those references.

And also interesting that interest rates went lower in response to the Fed caring about inflation.

Also, the strong yen vs the pound and euro, for example, was the reaction to ‘stress’ type of move we saw beginning in August.

While the FOMC didn’t do much to alleviate stress per se, they didn’t actually *do* anything to make it worse, either, and there were signs it was running its course, with the year end issue the remaining
hurdle. I’ll be looking for signs the NY Fed is working on that tomorrow and watching to see if 3 mo libor comes back down over the next few days.

The CPI and PPI are expected to be off the charts Thursday and Friday, and the media could start harping on inflation, blame the Fed for high oil prices, questioning whether a half point in the funds rate over the last few months was worth a $20 increase in the price of crude, and continue pushing that theme if crude goes up as I expect it will, as Saudis continue to (irregularly to hide what they are doing) hike posted prices and let the quantity they pump vary. (and Russia
probably doing same as well.) At 120 crude, retail gasoline should be pushing $4 and food up as well via the biofuel connection, and the media attack on the Fed for letting the inflation cat get out of the bag can elevate expectations rapidly, with tips breakevens and Michigan expectations numbers elevating rapidly.

So far, higher crude means lower yields, as it is anticipated the economy will weaken and the Fed doesn’t care about inflation. If/when that changes- as evidenced by higher crude causing higher interest rates even with risk to gdp- tensions and stresses move up several notches, as anyone working through the 70’s and 80’s should recall.

Given the coming inflation numbers, a segment of the mainstream will start to point out that the ‘correct’ fed funds rate is about 7% with inflation at about 4. To them a neutral real rate would put the ff rate at 6, so it will take 7 to be restrictive. They will argue headline cpi is the rate to use, as food and energy are trending and sustaining the higher levels, along with import and export prices rising at more than 5% rates, and therefore this group will give greater weight to core moving up to headline as happened in the 70’s when crude trended upwards for an extended period of time. And should crude continue to move up, this initially small group of mainstream economists will grow, and CNBC will help promote this ‘scare story’ as it attracts more and more viewers.

Hoping things don’t go that way but concerned they will. Looking forward to reactions to the data later this week and what commodity prices do from here.


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