US rates futures fall on renewed jitters: three-month interbank rates drift to record lows

US short-term interest rates futures for delivery in 2010 fell on Friday on renewed anxiety over the Federal Reserve's tightening monetary policy, even as three-month interbank costs slipped to fresh lows. Worries over the Fed raising rates sooner than some traders had thought were revived after a Wall Street Journal opinion piece by Fed Governor Kevin Warsh.
A drop in the dollar also exerted downward pressure on US rates futures after a draft G20 statement showed leaders of the developed and emerging countries plan to keep their emergency support until their economies recover. Futures contracts on federal funds, which the US central bank targets, fell as much as 6 ticks. Eurodollar futures for 2010 delivery were down as much as 7 ticks, while most contracts beyond 2010 gained up to 7 ticks.
"Fed funds futures selling off underscores the markets' knee-jerk reaction to dollar defence comments overnight, but this is egregiously premature," said Christian Cooper, an interest rate strategist with RBC Capital Markets in New York.
The dollar hit a 7-1/2 month low against the yen on Friday in the wake of the G20 communiqué. The sell-off in US rates futures contrasted with the ongoing decline in three-month London interbank offered rates. Three-month Libor on dollars dipped to a record low of 0.28250 percent. Equivalent rates on euros and sterling fell to fresh troughs of 0.69875 percent and 0.55125 percent, respectively.
Moreover, the drop in rates futures widened the risk premiums on short-dated dollar interest rates swaps over Treasuries, although analysts said the market reaction is overdone. Two-year swap spread widened to 30.00 basis points from 29.50 basis points late Thursday. "Wider swaps spreads in the front end of the curve implying higher Libor rates, all else being equal, doesn't make sense unless the Fed starts to hike sooner than later," RBC's Cooper said.