US Money Markets: Value in extensions given the aggressive Fed discount
The desk believes the current valuation of US money markets is overly aggressive, particularly given the Federal Reserve's recent actions. Per the full note from ing-think, the expectation of prolonged elevated interest rates seems exaggerated, creating value for extensions in tenors from nine months to two years. Additionally, the desk notes that the Fed's 25 basis point hike in September has further solidified rate hike pricing, with markets projecting potential cuts only in 2027 and 2028, contrary to market sentiment. While our consensus on EUR/USD stands at 1.1700, we will need to monitor upcoming economic indicators carefully as traders realign their expectations on monetary policy tightening.
What the desk is arguing
The desk argues that the aggressive pricing in US money markets reflects an overestimation of future rate hikes by the Federal Reserve, which presents an opportunity for value in longer tenors. Per the full note from ing-think, the market's current discount suggests that the funds rate will remain elevated, which may not align with the Fed's potential pivot towards rate cuts by 2027-2028.
Supporting this view, the desk highlights that the carry spread between the Fed funds rate and the 3-year rate has returned to a 100 basis point spread, indicating a strong discount for possible rate hikes. A critical point made was the current pricing of the 10-year SOFR, which suggests a funds rate averaging 5% for the next decade, a stance perceived as aggressive if viewed against historical tightening cycles.
Where it sits in our coverage
Our current consensus target for EUR/USD is 1.1700, with a range of 1.1200 to 1.2000. Notably, firms such as morganstanley and rbc have set targets for December 2026 at 1.2150 and 1.2000, respectively.
This view is somewhat aligned with the broader market expectations. The desk's perspective suggests a potential upside towards the upper end of the forecast range as rate hike fears further consolidate in the market.
How other firms see it
Firms such as socgen and barclays share similar bullish sentiment towards EUR/USD, with targets around the mid-1.1700s. In contrast, danskebank holds a more cautious view with targets indicating a potential drift towards 1.1200.
Additionally, watch GBP/USD closely as the trajectory here will interact with the BoE’s rate outlook, alongside USD/JPY, which remains sensitive to both US monetary policy and the BoJ’s stance on interest rates.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01The desk sees current US money markets as mispriced due to overestimation of future rate hikes.
- 02Described value exists in extending tenors between nine months to two years.
- 03Consistent rate hike fears contribute to a significant carry spread, suggesting market overreaction.
- 04Potential Fed pivots towards rate cuts are projected for 2027 and 2028.
Market implications
Keep a close watch on EUR/USD around the 1.1700 level as sentiment around US interest rates evolves. Positioning shifts in response to economic data releases could alter consensus targets for currency pairs. Investors should look for indicators of Fed rate decisions that could impact outcomes significantly.
Risks to this view
Should the Federal Reserve continue to signal a more hawkish outlook or if inflation data were to accelerate unexpectedly, the desk’s call could face challenges. A surprise rate hike or a more aggressive rate hike path than currently priced in would serve as a significant counterpoint to the desk's current stance.
EUR/USD — All Desk Targets
| Firm | Stance | YE 2026 |
|---|---|---|
J.P. Morgan | Bearish | 1.1300 |
Crédit Agricole | Bearish | 1.1300 |
Goldman Sachs | Bearish | 1.1200 |
Articles US Money Markets: Value in extensions given the aggressive Fed discount Published 09:00 Rates Share X LinkedIn E-mail Copy link Share X LinkedIn E-mail Copy link Download The Fed has hiked and the market is positioned for more. Moreover, the discount is there for maintaining an elevated funds rate for a prolonged period. We think this is overdone and presents value in longer tenors (nine months to two years).
Pickups into credit remain mild, so an extension on the core product is good enough. Liquidity remains supportive Padhraic Garvey, CFA The Federal Reserve raised interest rates by 25bp in September. Markets are expecting more rate hikes, but we see rate cuts in 2027 and into 2028 The call on the Federal Reserve Fed Chair Kevin Warsh delivered on the market discount, and did so after all the talk that this Federal Reserve would do things differently.
It was still an eloquent performance. The 2yr was a tad spooked by the Committee's unanimity on the 25bp hike (Chair Warsh voted for it too) and the implied priming for another hike from the dot plot. Since then, the rate hike discount has hardened and intensified further.
The carry spread (Fed funds rate to the 3yr) is back out to 100bp. Neutrality on that spread is about 30bp, so the remaining 70bp is a rate hike discount. Ahead, we think there are enough rate hike fears discounted at this juncture.
Remarkably, the current 10yr SOFR is priced as if the funds rate is heading to 5% and will average here for the coming 10 years. That seems to be quite an aggressive long-term discount, even if the Fed does overshoot to the upside as a theme for the remainder of 2026. More likely, in our opinion, is that the Fed ultimately turns tail and cuts rates in 2027 and 2028, where a return to the 3.5% area is anticipated.
The Fed balance sheet narrative Since the Fed recommenced T-bill buying in mid-December 2025, it has bought a cumulative $360bn. Overall, the Fed's holdings of all securities (including bills) are up $235bn, to almost $6.4tr. Chair Warsh came into the job in the wake of various suggestions that the Fed should reduce the size of its balance sheet.
We covered the issue here , and noted that at the end of 2005, the Fed’s balance sheet was about 5.5% of GDP. Roll on 20 years, in and out of the global financial crisis (GFC) and pandemic, and it’s now 21% of GDP (quadrupled). The driver was bond buying.
Total bonds held by the Fed were around 5.5% of GDP 20 years ago. That now equates to 20% of GDP (almost quadruple). Bank reserves were purely regulatory in nature and a puny 0.1% of GDP 20 years ago.
Sources & References
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