Prior Week Summary
The aftershocks of the financial crisis are still being felt nearly a decade after the onset, as fresh concerns of counterparty credit risk in the financial sector precipitated a flight-to-quality trade in the Treasury market. The risk-off sentiment took the 10-year note lower in yield by nearly 8 basis points early in the week, flattening the curve along with it, before reversing course to end the week roughly where it began. Jittery markets, influenced by the pending implementation date for money market reform, combined to push quarter-end funding rates to their most stressed levels since the crisis.
Repo rates soared into quarter-end as financial institutions reduced balance sheet leverage, amplifying the supply/demand imbalances in the money markets. Overnight Treasury financing costs spiked to a spread of nearly 80 basis points over effective Fed funds during the week, levels that haven’t been seen since the 2008 timeframe. At the same time, the amount of cash that market participants have placed with the Fed grew to a massive $415 billion at quarter-end, nearly five times the yearly average.
However, it appears that as of this writing, the quarter-end stresses have already begun to subside. Despite all of the noise in the markets last week, traders are largely still pricing in a December hike, with an implied 60% probability of a 25 basis point move. Some analysts have pointed out that the market is actually more confident of a hike in December than at this same point last year, when the Fed last raised borrowing costs.
The Look Forward
The marquee report to look forward to this week will be the update to non-farm payrolls on Friday, which traders will parse through for any clues on Fed direction. The Bloomberg consensus estimate is for a gain of 173k jobs, relative to the addition of 151k jobs in August.