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The Fed: A Rate Hike or No?

The Fed: A Rate Hike or No?

The odds of a rate hike coming out of this month’s Fed meeting shot up last week, roiling not just the Treasury market, but stocks and gold as well.  

Well, “shot up” may be overstating things a bit. The odds, implied by the Fed Funds futures market, ended up rising just 10 percent between Wednesday and Friday, but that was a jump from 15 percent to 25 percent. Proportionally, it was a big move.

Friday’s cross-market losses suggested that traders were caught off-guard.

By what?

Two things, really: First, investors’ uncertainty on rates turned to fear as Fed officials seemed to adopt a more hawkish tone in their public comments. This was then compounded by a European Central Bank decision to stall further easing on the continent.

The effect on the Treasury yield curve was striking. The spread between the two-year and 10-year T-note ticked up by 10 percent, or 8 basis points while the long bond’s yield vaulted 16 basis points.

The move translated to a nearly 3 percent knockdown in the price of the iShares 20+ Year Treasury Bond ETF (NYSE Arca: TLT) together with a dramatic confirmation of downside momentum in the ETF’s MACD indicator.

Punters betting on a rate hike piled into the ProShares UltraShort 20+ Year Treasury ETF (NYSE Arca: TBT), contributing to a 7 percent price jump. The fund, now trading at the $32-$33 level, aims to produce -200 percent of the daily return of its underlying Treasury bond index. Think of TBT as the double inverse of TLT. TBT sports a 19-year duration, so for each 1 percent increase in the long bond’s yield, the ETF’s price ought to rise by 19 percent.

Now caroming off a long-term bearish objective, TBT’s technically capable of reaching the $36 level in this rebound. That roughly translates to a 60 basis point hike in the long bond yield, now at 2.39 percent.

All this, of course, is event dependent. The Fed goes dark a day ahead of its FOMC (Federal Open Market Committee) meeting, slated for Wednesday, so Monday’s speech by Governor Lael Brainard, the central bank’s most dovish official, will be meticulously parsed by traders and pundits. Any hint of hawkishness from her is likely to keep the pressure on bonds. And stocks. And gold.

Brad Zigler is WealthManagement.com's Alternative Investments Editor. Previously, he was the head of Marketing, Research and Education for the Pacific Exchange's (now NYSE Arca) option market and the iShares complex of exchange traded funds.

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