Where are the trading desks of the Federal Reserve System and the European Central Bank moving markets? Back in mid-December, the Federal Open Market Committee directed its trading desk at the Federal Reserve Bank of New York to undertake open market operations to maintain the federal funds rate between the target range of 4.25% and 4.50%.
Open market operations involve buying and selling securities, usually government debt, in order to maintain the target range for setting the overnight interest rate at which banks exchange excess reserves.
Another tool for establishing the target range for the federal funds rate is the overnight reverse repo rate. The ON RRP process involves the Federal Reserve Bank of New York’s trading desk selling a security to one of its eligible counter-parties. At the same time, the FRB-NY and the counterparty agree that the FRB-NY will repurchase the security by the next day.
The counterparty buys the security from the Fed at a minimum rate of 4.25% but sells it back at a maximum of 4.50%.
Meanwhile, the European Central Bank appears to be directing its trading desk to not buy any additional securities. That appears to me to signal a reduction in demand for European securities leading to a reduction in the price of these securities with a corresponding increase in their yields.
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If yields in Europe do climb, why wouldn’t proprietary traders not want to rotate into the Eurozone? Likely, by most financial media accounts, because the Eurozone is experiencing a political economy more uncertain than the United States’ economy. The European short-term rate, which is similar to the U.S. four-week T-bill rate, fell from 3.164% on 12 December to the current 2.91% today.
At first blush, one could argue that declining yields indicate an increase in European bond values or a reduction in risk. To investors looking for income, declining yields tell me underwriters rather look for another economy to make a return on investment.
I wonder if Europe is becoming the next carry trade?
I am betting that the EUR/USD goes above 1.0288 but no higher than what the CME Euro FX futures is priced at, 1.0462.
Alton Drew
29 December 2024
If you are in need of a legal or political risk assessment regarding your trading environment, reach out to me on LinkedIn or email me at altondrew@altondrew.com.
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