Thursday, November 02, 2006

Where Market Is Now -- The 170% Solution

It has been a week for bullish sentiment as far as bonds are concerned. The probability pricing for a Fed ease, diminished only a couple weeks ago by Fed speakers and then rekindled by the FOMC statement (go figure), has moved to a full flame-on frenzy based on ISM and other assorted just released data. Not even the first shot across the party boat's bow, Dallas Fed Chairman's chat today at the New York Association of Business Economists, could take the punch bowl away from this celebration of impending economic gloom (bond people are natural pessimists, if they were optimists they would've gone into equities).

Rather than opine on Mr. Fisher's comments and try to establish what is really meant by inflation (see my blog on the subject), I figured it was prudent to wait till after the big number is out tomorrow morning.

So in the interest of the public interest, or at least those that read my blog, I offer the table of market probabilities -- as compiled by my partner Stan Jonas.

Note that the Thursday column shows a cumulative probability of a 170% chance of a Fed ease by Aug 07. Meaning 25bp is baked in and there is a 70% chance for the next 50bp. Which, in our terms is pretty much 100%.

Once again, if the data continue to support the negative view on growth the Fed will ease in January (where the market is pricing in only a 1 in 5 chance of an ease) by 25b or even 50bp. Why anyone thinks they will wait til Mar is beyond me.

If the data stabilize, disappointing the gloomy ones, and the market prices to the "on hold" scenario (JHLD column), the two-year backs up approximately 40bp. Will that happen? No one knows for certain, but things always seem worse than they are when the economy is in the midst of a downshift. Still, it is always helpful to know the risk you are taking from what you are buying.

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