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non-synthetic futures and option strategies

low rates seen as inflation trigger

chicago (14:06 et)-in a reaction that seems contrary to typical market moves, the release of weaker-than-expected economic data friday sparked concern about long-run inflation among some traders of u.s. interest-rate futures. that's because the data convinced market participants that the federal reserve won't raise rates anytime soon, a policy that some view as triggering inflation.

friday's action featured a steepening of the yield curve, meaning the market sees short-term rates falling at a faster pace than long-term rates.

inflation risks tend to raise yields with lengthy maturities, as the market seeks to entice investors otherwise reluctant to have long-run inflation diminish their fixed rates of return.

also apparent from friday's trading was that traders were not necessarily seeking safe havens, including contracts linked to u.s. government-guaranteed debt. higher-risk stocks would have moved lower if safety was the motive.

instead, the stock market was higher during friday's holiday-shortened rate futures session.

"it's not consistent with a flight-to-quality trade," remarked glenn holland, managing director of cq solutions, a chicago-based broker-dealer.

holland noted that the decline of the u.s. dollar on friday boosted demand for u.s. denominated assets like stocks and bonds.

friday's major market-moving catalyst was a report on the still-depressed housing market. the national association of realtors friday said that its seasonally adjusted index for pending sales of existing homes plunged 11.6% in april, and down 26.5% on an annual basis.

the data provided additional evidence that the fed intends to keep massive stimulus flowing in the financial system, including a near-zero fed-funds rate.

the rate-setting federal open market committee has held its funds rate target inside a record low range of 0% to 0.25% since december 2008 to help the economy recover from the deepest recession since the 1930s.

at friday's settlement, fed-funds futures, as listed at cme group inc. (cme), priced in a 52% chance for the fomc to raise the funds rate to 0.5% at its meeting in late june of next year. that's down from a 56% chance at intraday levels early friday. the market priced in a 100% chance for a 0.5% rate less than two weeks ago.

the may 2012 fed-funds contract was unchanged friday, pricing in a 24% chance for the initial tightening to occur at the late april 2012 fomc meeting.

meantime, eurodollar futures prices rallied on the pending home sales data, also emblematic of the view that short-term rates will stay down.

june 10-year treasury note futures price reached a six-month high following the data, a move that dropped the contract's implied yield closer to 3%.

prices settled a little lower for june classic and ultra treasury bond futures on friday, amounting to expectations for slightly higher long-term rates and a steeper yield curve.

classic treasury bonds cover 15- to 25-year maturities. ultra treasury bonds are for maturities longer than 25 years.

after the long memorial day weekend, september replaces june as lead-month contracts for treasury futures.

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