Daily Clueless Musings 5/18

Finally we have some actions in the market today. Front eurodollar contracts were under heavy selling pressure before the release of FOMC minutes. Inflation and exit strategy were the two main themes of the minutes. The minutes said that “Many participants had become more concerned about the upside risks to the inflation outlook.” , however on economic activity the minutes said that “Although most participants continued to see the risks to their outlooks for economic growth as being broadly balanced, a number now judged those risks to be tilted to the downside.” As commodity prices have come down and industrial activities have cooled down since the April meeting, Fed likely has tilted toward more accommodative policy. Ironically, as Fed seems to be slightly accommodative than the market had expected, stocks and commodities all traded higher after the minutes and yield curve steepened. More importantly, the minutes also laid out details of their exit strategy. The sequence will probably be: 1) End of QE2 at the end of June, 2) stop reinvestment payments of principal on agency securities. Therefore the size of the balance sheet will the first signal of the tightening cycle 3) removing "exceptionally low levels for the federal funds rate for an extended period" 4) Rate hike is like to come two meetings after. 5) sales of securities will come after rate hikes. Futures finally have a down day today. It is not because the expectation for next rate hikes is not pushed forward. Futures just price in too much certainty. Although FOMC provided the market more details on their exist strategy, the expected monetary policy is contingent on assumptions of inflation and economic activities. The effect of ending QE2 and fiscal policy are way more uncertain than what the current market has priced in. Vols remained very cheap on this down tick. There are not much options flows, even as futures made a significant turn today. Paper has not yet put on big bearish trades or take off their bullish trades. It is interesting to see how the market will reaction, if the sell off follow through.