SpreadEx Terminal Rate Part 2

Hi there!

In our last post, we referenced the terminal rate, what it is and why it’s important in this lovely concise post for you.

It’s time to update that viewpoint dramatically!

In the chart above, you can see the Fed Funds price term structure, which is effectively showing you interest rate pricing (y-axis) across different tenors (put simply, months denoted by the traded contract code on the x-axis).

It might be confusing at first because the price makes no sense on the y-axis, but all you have to do to find the expected target range for that period is find the difference between 100 and the current tenor’s price.

For example ZQQ3 (August 2023) is showing about 94.75, which means the expected interest rate there would be 5.25% (100-94.75 = 5.25).

This is higher than what the market had priced for the last 5 months.

September is then when the market expects cuts to enter into the picture…

But here’s the problem.

If we look at the interest rate pricing from earlier periods, we can see the shift in the term structure.

Since November last year and more surprisingly from January, there has been a rapid repricing in the interest rate path, which has resulted in reflecting the ‘higher for longer’ interest rate policy, likely led by strong employment data and the shelter component of housing simply not budging.

This is certainly a cause for concern for risk assets as models reprice equities into a new, almost micro regime.

See, for so long, it was expected that 5% would be the peak rate, but we seem now to be repricing quickly for a higher terminal rate of interest, and Tuesday’s CPI number largely confirmed this.

Interestingly, equities are remaining flattish - this is probably a reflection of employment staying strong and so the well overused term ‘Goldilocks’ being in full flow.

But under the surface, the dollar is starting to perk up again, which is almost certainly in relation to the Fed being more keen than other central banks to remain hawkish (for example, the Bank of England is looking to stop their hiking cycle in March while inflation is still a good few multiples above target - make of that what you wish!).

EURUSD is down ~300 ticks or so after it breached 1.10 in early February and many analysts turned uber bullish for no specific reason.

Commodity currencies like the Aussie and Cad are similarly facing weakness through February.


Key to note is that this has largely been driven by the blowout employment figure and the repricing of said terminal rate (the recent bottom for the dollar came on Feb 3rd, the day of the NFP).

But those of you who are following will understand this already and see that the interest rate pricing expectations are the number 1 priority when analysing the next few months.