Great Graphic: The Yellen Effect

This Great Graphic was generated on Bloomberg.  It shows the price of two financial instruments.  The yellow line is the price of the December 2015 Fed funds futures.  The white line is the price of the December 2015 Eurodollar futures contract.  

Both contracts sold off hard yesterday and are lower today.  From yesterday's high to today's low, both contracts have fallen about 20 ticks.   

The implied yield (subtract price from 100) of the Eurodollar futures contract is 119 bp, up from about 97 bp at the lowest yield level yesterday before outcome of the FOMC meeting.   The implied yield of the Fed funds futures contract has risen from about 62 bp to 81 bp.  

It is fair criticism of this observation to note that the December 15 Fed funds futures contract, which settles at the effective average rate of the month, may be distorted by the year-end roll.  That is less significant in the Eurodollar futures contract.  However, both contracts indicate that it was not quite prepared for the outcome of the FOMC meeting.  

Before the FOMC meeting, we suggested that the measure of the Chair's success would be how little expectations for Fed tightening would change.  This was on the assumption that the Yellen wanted to demonstrate continuity with the Bernanke Fed and the strategy that was put into place.  Indeed, Yellen herself said there was not change in the FOMC policy intentions.  The market suspects otherwise and a good night sleep has not changed those suspicions as both futures contracts we are discussing of implying a higher yield now that at yesterday's close.  

We would expect "clarification" in the coming days by Fed officials to drive home the point that rates will be low for longer.  Surveys of primary dealers will also show that while the risk of an early rate hike may be above zero, most will continue to look for the first rate hike in Q3 15 not Q2 15.  The risk that the first rate hike is delivered in Q4 15 rather than Q3 15 seems greater than the odds of a Q2 move.