(USTs are higher / flatter on above avg volumes) while WE slept; 6 recession indicators; love letter from Yellen TO McCarthy and a 'June deadline afterall? (GS); construction (of forward yields (FRED)
Good morning … Sorry to say but this mornings note will continue as normal DESPITE the writers strike (I know deep down you were hoping yer inbox would get a rest…spam filters workin OVERTIME these days with the auto warranty guys working hard)
Buy (bonds on) the rumor and sell (bond on) the fact?
If I WERE in the business of drawing lines in the sand, 10yy vs 3.65% or so would be a good place to start,
Momentum adjusted firmly BEARISH on the daily BUT once again on verge of BULLISH cross from unconvincing (ie middling) levels. This is as opposed to longer-term MONTHLY bullish setup so … buy dip? 50dMA approx 3.605%
… here is a snapshot OF USTs as of 705a:
… HEREis what this shop says be behind the price action overnight…
… WHILE YOU SLEPT Treasuries are higher and the curve is flatter this morning as hedger flows subside(?) after the ECB's Q1 lending survey showed banks tightening lending standards "substantially." (Link above). The RBA's pause lasted one month and they hiked by 25bp amid sticky inflation there... while the rest of the overnight news is shown above. DXY is higher (+0.15%) while front WTI futures are lower (-0.5%). Asian stocks that were open were mixed, EU and UK share markets are little changed this morning while ES futures are showing -0.15% here at 6:55am. Our overnight US rates flows saw an early Tsy rally in Asian hours snuffed about by the surprise RBA hike. We saw better buying in intermediates before the RBA announcement. London's AM hours saw muted flows with generally better buying across the curve and even in x-date T-Bills. Overnight Treasury volume was actually decent at ~140% of average overall (30yrs at 192% of their average turnover overnight).
… Our first attachment again shows Treasury 2yrs stuck in their ~3.77% to 4.25% range with daily momentum (lower panel) at middling levels and devoid of signal. "Tactical coin-toss" immediately comes to mind seeing this. The Treasury 5s30s curve is equally rangebound and also devoid of tactical signal right now.
… Moving on, our next attachment shows the historic decline in YoY commercial bank deposits and it's a picture that made the rounds in social media yesterday. It's not a great look for lending channels and maybe the economy generally, but many time series we watch are base-effected charts like this where we tend to think of them more as reflecting expected, 'equal and opposite reactions' so far...
… and for some MORE of the news you can use » IGMs Press Picks for today (2 MAY) to help weed thru the noise (some of which can be found over here at Finviz).
From some of the news to some of THE VIEWS you might be able to use… here’s what Global Wall St is sayin’ …
Heading in to TOMORROWS FOMC meeting and presser, it’s hard NOT to begin with this one from ABNAmro,
The last Fed hike? The Fed is expected to hike rates one last time on Wednesday, but we could be in for some further rate rises if the economy doesn't cool more quickly.
… Our base case is that May will indeed herald the last Fed hike of this cycle, but we see the risk tilted toward the Fed continuing to hike through the summer. The macro drivers have been conflicting of late. Consumption has surprised to the upside, suggesting resilience in the face of headwinds, but the trend since the pandemic has been for strength to be revised away, while recent high frequency data points to a rapid cooling in momentum. Meanwhile, the banking sector turmoil does look to have driven a tightening in bank lending standards, but it is still unclear whether that tightening will persist; a key input in this regard will be the results of the Fed’s Senior Loan Officer Survey, due out over the coming week (there is no official release date, but precedent suggests it will be out around 8 May). Given the significant uncertainty, we expect the Fed to shift to full data-dependent mode from the June meeting onwards. For now, our base case is that rates will hold steady at 5.00-5.25% for much of this year, with the Fed starting a rate cutting cycle from December. This assumes that a mild recession unfolds over the coming months.
From MAYBE more hikes TO Prof Siegel,
Prof. Siegel: Let’s Talk About the Fed Meeting This Week
… The Fed really should be in cutting mode with yet another drop in the money supply. Of course, they won’t yet. Money market ETFs are very attractive relative to checking accounts and they are not counted in M2. Maybe they should be eventually, like money market mutual funds.
What could stimulate the market this week would be a Powell statement that hinted at a pause in rate hikes coming at the June meeting.
If the message is ‘we need to see more evidence inflation is declining’ that could discourage the market.
Market-based indicators of inflationary expectations remain subdued. We have another bank, First Republic, under stress and by the time you read this commentary, there may be a resolution. Yet the markets are not concerned about this systemic risk. Deposits are safe. This is not like the banking stress in 2008, yet I remain concerned there may be a slowdown in the economy from tightness in lending standards. Let us hope Powell and company at the Fed recognize these risks this week.
There you go some extremely different views AND I’m certain there are lots in between … The good professor is NOT alone … there are countless research notes it seems out there defending the RECESSION call. A note from a large German shop lays out
1. The US M2 money supply has seen a noticeable contraction over the last year. Whether you consider it correlation or causation, all others on this scale have been associated with bad economic outcomes.
2. When the Fed have previously tightened this fast and this quickly, a recession has followed shortly afterwards…
What follows are Conference Bd LEI, temp help, 2s10s and perhaps the more important curve which the Fed has mentioned in past,
…6. Another yield curve cited by Fed research as a better indicator is now inverted on a scale unseen in available Bloomberg data. And looking further back, the Fed’s own data suggest inversions on this scale have historically coincided with recessions shortly afterwards.
Recession (or more hikes) aside, I learned something yesterday. I did NOT know the AAM distinction between suspense and surprise …
AAM VIEWPOINTS — FIXED INCOME REVIEW & OUTLOOK: THERE’S A DISTINCT DIFFERENCE BETWEEN SUSPENSE AND SURPRISE
The consequences of the Federal Reserve's (Fed) rapid tightening of monetary policy started to become clear in the 1st quarter as higher rates started to expose weak spots in the financial sector. The first casualty was California-based Silicon Valley Bank (SVB), which was reported as suffering significant losses on long-dated U.S. Treasury holdings. Regulators were forced to step in to guarantee deposits, but this wasn’t sufficient to prevent Signature Bank becoming the next casualty as markets started to pick off those regional banks perceived to have vulnerabilities. With fears of a new banking crisis, negative sentiment started to ripple out from the U.S. and across to Europe, ultimately forcing a regulator-driven takeover of Swiss bank Credit Suisse by UBS.
The Federal Open Markets Committee raised rates by 25 basis points (bps) at its March meeting, following a 25bps hike in February, but noted the stresses in the banking system and the potentially tighter lending standards that would result. Markets shifted to expect a further 25bps hike in May, with that marking the terminal rate of the current cycle.
Although we’ve long highlighted that the Fed generally tightens policy until something breaks, as Alfred Hitchcock said, “there’s a distinct difference between suspense and surprise.” The abrupt change in market sentiment seen in March highlights the importance of hedging plan liabilities and locking down certainty.
We believe credit markets now offer significant opportunity…
… and we are told there’s a creative WRITERS strike going on out there … good thing sellside NOT included!
With debt limit in mind, a couple links
ZH: Yellen Warns Treasury To Run Out Of Cash As Soon As June 1 Absent Debt Ceiling Deal
A June Deadline After All? BOTTOM LINE: Treasury Sec. Yellen has informed Congress that the Treasury will exhaust funds under the debt limit “potentially as early as June 1” but possibly “a number of weeks later”. While we thought the Treasury would be able to pay obligations until late July under the debt limit, the early deadline is not surprising, given that we project Treasury’s cash balance could dip as low as $25-30bn in early June, which is roughly the minimum cash balance Treasury usually uses to project its deadline. There is little time to negotiate a deal, with the House and Senate in session at the same time for only two weeks before early June. This raises the odds of a temporary extension in our view, though we expect the parties to initially begin negotiations toward a deal with the possibility of a short-term extension as a fallback.
And so as economics continues to confront politics, we’re left to debate and contrast how it is different this time and on THAT note (no, it’s never different this time) a visual from the intertubes. As you know I believe EVERYTHING I see on the web, especially fintwit and here’s an (economically NOT workbenched) visual from Tavi Costa’s shop for fun,
2023 has already been the biggest year for bank failures by assets in US history, and the year is not over.
Note how the number of bank failures historically has lagged vs. assets, meaning that bigger banks fail first, then a greater number of smaller failures come after.
How can we be sure there aren’t any big ones still lurking?
Jamie Dimon is hopeful that government actions have stabilized the industry, but he also concedes that bank lending will probably suffer for a time. Something doesn’t add up:
1. The Fed is still tightening. 2. A recession hasn’t even started yet. 3. Equity valuations remain extraordinarily high. 4. Credit spreads are still extremely tight.
The risk of a hard landing seems much higher than is currently reflected in the markets.
What to do and make of ALL this? Well, for that I’ll turn TO BlackRock’s latest with a reminder,
•We see bond yields staying high in the new macro regime – that means income is back as a portfolio driver. We stay nimble and granular across fixed income.
• U.S. stocks rallied from a four-week low last week after tech earnings beat. Yields fell even as data confirmed slowing growth and persistent wages and inflation.
• This week we see major central banks hiking rates again. We don’t see cuts this year. We also expect U.S. jobs data to show a tight market still fueling wages.
Yield is back: The share of fixed income indexes yielding over 4% is at its highest level since 2008 (see the chart).
But lets NOT get too complacent as the firms MACRO TAKE notes,
Momentum in consumer spending slowed through the first quarter after a strong January, according to last week’s U.S. spending data. We expect spending to drop in coming months as households run out of pandemic savings. Annual headline inflation cooled to 4.2% but annual core inflation remains high at 4.6%, as core services inflation eased but core goods inflation returned. See the chart. The Employment Cost Index release showed annual wage growth running at nearly 5%. If that pace continues, services inflation will stay sticky and overall inflation will stay well above the Fed’s 2% target.
This highlights the difficult trade-off the Federal Reserve continues to face: With inflation this persistent, the only way to get it back near 2% is by generating a recession. And it’s why the Fed is willing to tolerate economic damage and financial cracks like we’ve seen recently in the U.S. banking sector. We still believe market hopes for rate cuts this year are misplaced, given the persistence of inflation…
Have cake. Eat cake, too. Good cop. Bad cop.
Oprah. Uma. Uma. Opah.
Finally, for those with an interest in CONSTRUCTION (no, NOT construction spending and so, GDP but…) something from FRED
A forward interest rate is a rate that pertains to a future loan and/or bond purchase. A forward transaction can be arranged in an over-the-counter market with a financial institution, or it can be constructed from existing fixed income instruments. A forward rate contract has at least two elements: the contract start and length. For example, a forward loan contract might commence 2 years in the future and last for 6 months. Such a contract might be termed a 6-month contract, 2 years ahead. Interest rate contracts (bonds or loans) that start immediately (or nearly so) are called spot market contracts.
Under the often-implicit assumption that financial markets price assets in a risk-neutral manner, analysts often use forward rates as market expectations of future interest rates. In other words, analysts often assume that the interest rate that one can lock-in today for a future transaction is the market’s expectation of that interest rate. With this interpretation, many analysts use forward rates to infer information about market expectations of variables such as monetary policy, output and inflation, and currency movements. For example, Hausman and Wongswan (2011) show that the 3-month forward interest rate, 1 year ahead, is closely related to what Gürkaynak, Sack, and Swanson (2005) refer to as the “path” monetary policy shock.
How can we determine the interest rate that should prevail on a forward contract, assuming that markets are working reasonably well? For concreteness, let’s think about the zero-coupon rate that should prevail from 2 years in the future until 10 years in the future. That is, we will consider the 8-year forward rate, 2 years ahead.
To see the relation between the 8-year forward rate, 2 years ahead, and the 2- and 10-year spot rates, let’s think about two ways that one could invest/lend a sum of money for 10 years.
Buy a 10-year, zero coupon bond.
Buy a 2-year bond and a forward contract to buy an 8-year bond at the end of the 2 years.
If one invests $1 on the first strategy, one obtains the compounded, 10-year gross yield: (1+i0,10)10, where i0,10 is the annually compounded interest rate paid from now (time 0) until year 10. Likewise, the first leg of strategy 2 yields a payoff of (1+i0,2)2, where i0,2 is the annually compounded interest rate from time 0 to year 2. At year 2, this payoff to the first leg is then invested for 8 years at the forward interest rate to get a total payoff of (1+i0,2)2 (1+i2,10)(10-2), where i2,10 is the annually compounded interest rate from year 2 to year 10.
The payoffs to the two strategies must be approximately equal or arbitrageurs would bid up the price of the cheaper strategy and short the more expensive strategy, driving its price down. The equation below shows the relation between the forward rate (i2,10) and the two spot market rates (i0,10 and i0,2). (1+i0,10)10=(1+i0,2)2 (1+i2,10)(10-2)
More generally, using time t0 as the base date and annually compounded interest rates, the gross forward interest rate at time t0, from time t1 to t2 can be represented as follows: (1+i(t0,t2))(t2-t0)=(1+i(t0,t1))(t1-t0) (1+i(t1,t2))(t2-t1)
Solving for the forward rate alone, which is used in constructing the graphs, is as follows:
The above formula is strictly applicable only for zero-coupon bonds—that is, bonds whose only payoff is at maturity. But, depending on the purpose, it might produce a reasonable approximation for bonds that pay coupons.
FRED has 10 forward interest rates that are derived from the Kim-Wright term structure model: 10 instantaneous forward rates, from 1-, 2-, 3- … to 10-years hence. These “instantaneous” forward rates are theoretical constructs for an interest rate that applies to loans of arbitrarily short duration. In practice, these are most reasonably interpreted as approximately overnight rates.
You might wish to construct your own forward rates with different characteristics in FRED. To give you a hand, we construct 2 different forward rates below, an 8-year forward rate, 2 years ahead, and a 3-month forward rate, 3 months ahead.
Example 1: The following directions describe how to construct an 8-year forward rate, 2 years ahead. The graph is at the top of the blog post.
In the FRED search box, type in “Fitted yield on a 10 year zero coupon bond” and select the series of that name. Graph the series.
Select “Edit Graph.”
In the series selection box under “Customize data,” type in “Fitted yield on a 2 year zero coupon bond” and click “Add” to add the series.
To construct an 8-year forward rate, 2 years ahead, type the following formula into the formula box: 100*((((1+a/100)^10)/(1+b/100)^2)^(1/8)-1). Then click “Apply.” The 100s in the formula convert the interest rates between percentage and decimal terms.
To compare the constructed 8-year forward rate, 2 years ahead, to the 10-2 Treasury spread offered by FRED, click on “Add Line” and type “10-year Treasury Constant Maturity Minus 2-year Treasury Constant Maturity” in the search box, then select that series and click “Add data series.”
To compare the 10-year Treasury rate with 8-year forward rate, 2 years ahead, select “Add line” in “Edit Graph” and type in “Market Yield on U.S. Treasury Securities at 10-Year Constant Maturity, Quoted on an Investment Basis,” then click “Add data series.”
To see the series over a common sample, set the start of the sample at 1990-01-02.
Perhaps not surprisingly, the graph shows that this forward rate is highly correlated with the 10-year Treasury rate. Coming out of recessions, the 10-2 spread tends to be high, as in 1992, 2003, or 2010, and the forward rate tends to exceed the 10-year rate. But when the 10-2 spread is near or below zero, as in 1998, 2006, or 2019, the yield curve is said to be inverted and the forward rate and the 10-year yield are nearly identical.
Example 2: The following directions describe how to construct a 3-month forward rate, 3 months ahead.
In the FRED search box, type in “Market Yield on U.S. Treasury Securities at 6-Month Constant Maturity” and select the series of that name. Graph the series.
Select edit graph.
In the series selection box under “Customize data,” type in “Market Yield on U.S. Treasury Securities at 3-Month Constant Maturity” and click “Add” to add the series.
To construct a 3-month forward rate, 3 months ahead, type the following formula into the formula box: 100*((((1+a/100)^.5)/(1+b/100)^.25)^(1/.5)-1). Then click “Apply.” The 100s in the formula convert the interest rates between percentage and decimal terms.
To compare the constructed 3-month forward rate, 3-month ahead, to the federal funds target offered by FRED, click on “Add Line” and type “Federal funds target range, upper limit” in the search box, then select that series and click “Add data series.”
To similarly add the lower limit of the federal funds target range, click on “Add Line” and type “Federal funds target range, lower limit” in the search box, then select that series and click “Add data series.”
To see the series over a recent sample, set the start of the sample at 2015-01-01.
The 3-month forward rate, 3 months ahead, is interesting because it can illustrate how financial markets anticipate monetary policy movements. The graph shows that it started to rise before the start of federal funds tightening cycles in 2015 and 2022 because markets correctly anticipated that a tightening cycle was about to start. The 2020 fall in the 3-month forward rate, 3 months ahead, was nearly coincident with the decline in the federal funds target rate because the latter was a reaction to the economic implications of the spread of the COVID-19 virus. Thus, the monetary easing was not anticipated very far in advance.
I’m personally saving this one to my Fred dash. Too much info? Oversharingis overcaring
There is never too much information on markets, thank you for the write up!