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Contradictions: The Fed vs. the Bond Market
The following is excerpted from John Mauldin’s latest weekly E-letter. The main contradiction we will deal with starts with a lunch conversation I had with bond market analysts and guru Jim Bianco two weeks ago in Chicago…We were talking hedge and macro funds, and he asked me what I thought was the best “trade” I saw. I answered that for aggressive traders, I liked the Eurodollar options. I will explain them in more detail below, but they are pricing in a Fed interest rate rise of over 1.75% by December 2004, which is just 14 months from now. I opined as how I did not think there is a significant chance of such a magnitude of a raise actually happening, and that I could not understand how the bond market could actually believe the Fed would raise rates that fast. Jim replied, “They don’t. The Eurodollar futures mis-pricing is a result of Fannie Mae and Freddie Mac distorting the market.” As he explained his reasoning, and as I have thought about it since then, I think he may have an answer for part of the puzzling contradiction between what the Fed is saying and what the market is pricing.