Confused? What to Watch

The focus of the market has shifted from the euro zone debt crisis, which seemed to have helped lift the dollar in the first week of the New Year to the shifting interest rate expectations, especially in the euro zone and UK.

This has clear implications for market participants. Watching 10-year bond yields and/or credit default swaps may not important guides currently. Rather short-end rates that capture short run interest rate expectations may be more important. OIS/LIBOR spreads may be preferable, but as you will recall from the crisis, LIBOR used in these calculations is the composite of numerous banks and there is some divergence, which may reflect risk appetite of the contributing banks and the counter-part risk associated with it. For example, today the 3-month LIBOR was fixed at 0.30313% and range of contributors was 28 bp to 40 bp.

For transparency purposes, market participants may want to monitor the Euribor futures and short-sterling futures contracts. Looking at the June 2011 Euribor futures contract first, we see that the implied yield has risen 1.035% to 1.365% as of yesterday. It is stabilizing today, which may correspond to a flagging of euro momentum.

The implied rate of the June short sterling futures contract has risen from about 87 bp on Jan 4 to about 116 bp as of yesterday. Like the Euribor contract, it is also stabilizing today and sterling is struggling to establish a foothold above $1.60.