- Fed officials today are likely to stress an unchanged outlook; UK and EU set to clash on reaching a trade agreement by year-end
- 30-year T-bond auction to yield near 2.36%
- UK and EU set to clash on reaching a trade agreement by year-end
Fed officials today are likely to stress an unchanged outlook — Six Fed officials have speaking engagements at various events today. The markets will pay the most attention to Fed Vice Chair Clarida, who is speaking this morning at 8 AM ET at the Council on Foreign Relations in New York. Mr. Clarida, as the Fed’s Vice Chair, is likely to carry whatever theme the Fed wants to communicate to the markets in the wake of the US/Iran tensions.
The Fed is likely to promote the theme that its outlook has not been changed by the recent US/Iran tensions. There have been some nervous moments in recent days about whether the US and Iran might stumble into a full-fledged war. However, US/Iran tensions subsided yesterday after Iran said it was done retaliating for the U.S. military’s targeted killing of Iranian General Soleimani and also said explicitly that it doesn’t want a war with the United States. Meanwhile, President Trump did not retaliate for Tuesday night’s missile attack by Iran on three U.S. bases in Iraq and he said that Iran was “standing down.”
There will be plenty of opportunities for US/Iran tensions to flare up again since Iran-backed militias may still shoot rockets at U.S. assets in Iraq and may launch their own independent attacks as retaliation for the U.S. killing of some of their leaders. In addition, Iran on Sunday said that it would no longer be bound by the restrictions of the nuclear agreement, raising the possibility of a new crisis if Iran resumes the aggressive enrichment of nuclear fuel and restarts its nuclear weapons program. President Trump yesterday promised that Iran would not obtain a nuclear weapon under his watch as President, which essentially would mean a war under the current circumstances.
Despite the simmering US/Iran tensions, the Fed can simply point to the markets to confirm that the U.S. outlook has not changed substantially because of the US/Iran tensions. The S&P 500 index and Nasdaq 100 index yesterday recovered from sharp overnight losses and rallied to new record highs, suggesting that stock investors are not particularly worried about the US/Iran situation. In addition, Feb WTI oil prices on Wednesday plunged by -4.9% and more than reversed the rally that was seen after the U.S. killed Iranian General Soleimani last Thursday night. Wednesday’s plunge in oil prices indicates that there is no oil spike as yet from the US/Iran crisis that could cause a global recession.
The Dec 2020 federal funds futures contract on Wednesday rose by +4 bp to a yield of 1.375%, indicating market expectations for a 25 bp rate cut by the end of this year from the current funds rate target midpoint of 1.625%. The Dec 2020 fed funds futures contract is now just 1.5 bp more dovish than it was last Thursday before the U.S. killing of Iranian General Soleimani. That indicates that market expectations for Fed policy are now essentially unchanged by the recent US/Iran tensions. Fed officials today are likely to reinforce the market’s view that the US/Iran tensions are unlikely to affect Fed policy unless those tensions take a new and severe turn for the worse.
30-year T-bond auction to yield near 2.36% — The Treasury today will sell $16 billion of 30-year T-bonds in the second and final reopening of November’s 2-3/8% 30-year bond of November 2049, thus concluding this week’s $78 billion coupon package.
The benchmark 30-year T-bond yield on Wednesday moved sharply higher from the overnight 1-month low and closed the day up +5.7 bp at 2.36%. The 30-year T-bond yield is now trading towards the upper end of the narrow range of 2.00%/2.44% seen since October.
The 12-auction averages for the 30-year are as follows: 2.25 bid cover ratio, $8 million in non-competitive bids to mostly retail investors, 5.7 bp tail to the median yield, 53.0 bp tail to the low yield, and 49% taken at the high yield. The 30-year is mildly below average in popularity among foreign investors and central banks. Indirect bidders, a proxy for foreign buyers, have taken an average of 58.8% of the last twelve 30-year T-bond auctions, which is mildly below the median of 60.8% for all recent Treasury coupon auctions.
UK and EU set to clash on reaching a trade agreement by year-end — UK Prime Minister Johnson is making good progress on getting Parliament to approve his Brexit withdrawal agreement by the Brexit deadline of Jan 31. There is virtually no question that the Brexit withdrawal agreement will be approved, which will usher in a transition period through Dec 31, during which the UK will continue to operate within the EU single market.
However, the question then becomes whether PM Johnson will be able to negotiate a trade agreement with the EU by the end of the transition period on Dec 31. If there is no trade agreement and if PM Johnson refuses to ask for an extension, then the UK will crash out of the EU single market on Dec 31 with no trade agreement and with tariffs suddenly rising to WTO levels.
PM Johnson on Wednesday met with new EU Commission President Ursula von der Leyen for the first time, and both laid out their red lines. PM Johnson demanded a Canadian-style free trade agreement and said that the UK would not agree to align with EU rules and standards. He also said that the UK would regain full control of fishing and migration rights. Meanwhile, Ms. von der Leyen said that the UK would be facing tariffs and trade barriers if it does not agree to substantially conform with EU standards on environment, labor, taxation, and state aid.
Ms. von der Leyen voiced major doubts about whether the EU-UK could negotiate a trade agreement by the end of this year. The EU-Canadian free trade agreement took seven years to negotiate.
