Aggressive Fed Discount Boosts US Money Markets
US money markets are experiencing value in extensions due to an aggressive Federal Reserve discount. Fed Chair Kevin Warsh's performance on the market discount has been eloquent, but it's had a spooking effect on the 2-year rate.
The rate hike discount has hardened and intensified further, with the carry spread (Fed funds rate to the 3-year) back out at 100bp. Neutrality on that spread is about 30bp, so the remaining 70bp is a rate hike discount.
Ahead, ING Think believes there are enough rate hike fears discounted at this juncture. The current 10-year SOFR is priced as if the funds rate is heading to 5% and will average here for the coming 10 years, which seems aggressive even if the Fed overshoots to the upside.
Chair Warsh wants to 'fix' the Fed's balance sheet, which has quadrupled since 2005. The technicalities could require the sale of all mortgage-backed bonds ($1.9tr) and at least half of the Treasury bonds (c.$3.6tr), bringing Fed bond holdings back down to around 5.5% of GDP.