(USTs MIXED, curve flatter on avg volumes) while WE slept; the elephant in the room; "...liquidity is poor and expectations for yield swings remain elevated..."
thebondbeat.substack.com
(USTs MIXED, curve flatter on avg volumes) while WE slept; the elephant in the room; "...liquidity is poor and expectations for yield swings remain elevated..."
(USTs MIXED, curve flatter on avg volumes) while WE slept; the elephant in the room; "...liquidity is poor and expectations for yield swings remain elevated..."
Good morning … The FOMC was, in my view (which again, I’ll remind you was not asked for and not likely what you signed up for), was quite clear.
Employment remains OK to good and inflation, while coming in a bit, still requires some work to be done. THIS, again in my view, means lower asset prices (ie stock AND bonds) and at some point … sets up a bullish steepening of yield curves (pick one, I discuss a couple below).
Another way to say this may be to check back in with 2yy on a somewhat longer-term — WEEKLY — perspective
Just a thought. Momentum here on a WEEKLY basis remains BULLISH (bottom panel) and any sort of meaningful dips will likely meet a wall of DEMAND … Staying tuned
Meanwhile, here is a snapshot OF USTs as of 705a:
… HEREis what another shop says be behind the price action overnight…
… WHILE YOU SLEPT Treasuries are mixed and the curve has pivoted flatter around a little-changed 10-year point. The BOE, SNB and Norges all hiked as expected, DXY is higher (+0.5%) while front WTI futures are little changed. Asian stocks were lower, EU and UK share markets are all lower too (SX5E -1.3%) while ES futures are showing -1% here at 7:15am. Our overnight US rates flows were unavailable at press time while overnight Treasury volume was about average overall with some relatively high average turnover seen in 5's (148%) and 2's (124%) overnight.
Treasury 10yrs, monthly: In the lower panel you can see the chronically 'oversold' condition that we chat about above. As we've said before, the flight-path of monthly momentum during 2022 looks eerily similar to the momentum path traced out during all of 2018 with QT a constant during both years, as you know. The set-up for an end-of-2022 flip to a new, long-term bullish momentum signal looks pretty excellent still (circled), despite the Fed's best efforts yesterday. It's just hard to out-hawk and already hawkish legacy positioning set-up?
Headline CPI (YoY%) and M2 money growth YoY% (18mo lead): This is the first chart we thought of after Tuesday's cooler-than- expected CPI print. We've posted this a few times in the past, generating considerable client comment and push-back after doing so (like: the level may be more important than the rate of change, said some). Well, all we know is that the correlation is holding up quite well so far where Milton Friedman ('inflation is always and everywhere a monetary phenomenon') may yet have a 'told you so' moment? Some clients said that being headline CPI misses what the Fed cares about: core inflation. But given the long-term positioning implied above, we wonder aloud if the optics of a rapid improvement in headline inflation is all the market needs to extend gains further...
Lets HOPE? Fed should know that HOPE is not a strategy … and for some MORE of the news you can use » IGMs Press Picks for today (15 DEC) to help weed thru the noise (some of which can be found over here at Finviz).
I will have some specific FOMC recapAthons and victory laps where the sellside tells us how they told us so … ZH does a better-than-good (‘nuff) job,
ZH: A Stunned Wall Street Reacts To The Unexpectedly Hawkish Fed
First, a few words about one of the Feds favorite yield curves via BBG and a visual from LinkedIN
By Edward Harrison (Bloomberg) -- Ahead of the Federal Reserve’s interest-rate decision later today, it’s notable that its favorite market signal of recession is now decidedly inverted. The near-term forward spread measures the difference between the current three-month Treasury bill rate and market pricing on where that rate will be in 18 months’ time. With financial conditions easing due to the recent rally in bonds, the Fed may need to push Treasury curves to even deeper inversion to maintain the policy restrictiveness that will slow labor market demand. That increases the potential for a hard landing.
According to the Fed, the near-term forward spread is a better indicator of future recession than the spread between two-year and 10-year Treasury yields. Chair Powell even talked to this in his March 2022 post-FOMC press conference. That inversion partially explains the Fed’s abrupt about-face in 2019 as the curve first inverted in January 2019, reaching a maximum inversion of 77 basis points in June 2019.
But the last business cycle was marked by far lower inflation than now. If the Fed is serious about fighting inflation then, the 2019 playbook is not a good guide. In fact, the nearly 90-bp rally in the 18m3m forward rate represents a massive easing of conditions which makes the Fed’s job harder. Perhaps Chair Powell will speak to this in the presser today since he himself was the one who called out this market signal of inflation in March.
Sans BBG and so, there’s NO visual of the near-term forward spread BUT next best — 3mo10yr (aka the financial curve) … here’s a visual I stumbled on yesterday from SurplusProductivity.com and Paul Winghart who detailed the move in the 3mo10yr spread,
Not much of a reaction out of the 3mo/10yr US Treasury curve today but its fair to say the real reaction to the Fed has happened over the course of the past few weeks / months.
YOU decide what, if ANY message being offered and whether or not to be heeded / traded in your portfolio.
Alrighty, then. SINCE the FOMCs words and deeds are still reverberating through markets and doing so just ahead of the ECB decision, lets address this elephant in the room (as opposed to THIS one)
Yesterday’s Federal Reserve policy decision is why the English language has the term “nothingburger”. Rates rose, the fabled dot plot moved, Fed Chair Powell bleated about really meaning to be tough, and markets did not care that much … Every young economist learns the mantra “never go short the hedonism of the US consumer” with good reason. However, after a very long period of very negative real wages, consumers may be less willing to spend. Retail sales data today will also reflect collapsing durable goods inflation.
The Fed leaned hawkish in its communications while downshifting the pace of tightening in its final scheduled meeting of 2022. Chair Powell welcomed the recent improvement in the inflation data, but similarly cautioned it would take “substantially more evidence” to become confident it is on a sustained downward path.
The tension between market pricing and the Fed’s interest rate intentions remains unresolved, in terms of both level and duration. The dot plot median shifted toward a terminal fed funds rate of 5.25%, consistent with our expectations. Furthermore, Powell went on to note there were no rate cuts implied in the 2023 dots.
The easing of financial conditions since mid-October featured prominently in Powell’s press conference, as it was referenced multiple times. Clearly policymakers are frustrated by an easing of conditions running contrary to their objectives.
Powell again denied the committee was anticipating (or engineering) a recession, but the economic projections took another sizeable step in this direction with exceptionally weak growth projected for 2022-23 and a larger rise in unemployment.
Our forecast for a 5.25% terminal fed funds rate remains intact after this meeting. However, there is some uncertainty over the path. We continue to anticipate a 50bp hike at the next meeting on 1 February, followed by a 25bp move on 22 March, but Powell introduced some ambiguity on his preferred size of move at the next meeting during his Q&A.
… While Chair Powell maintained optionality about the size of the next rate increase in February, we took his comments as supporting a further step down to 25bps at that time, conditions allowing. As such, we maintain our forecast for a 25bp hike in February and a terminal rate of 5.1% by May (see "US Outlook 2023: Dark side of the boom"). With a sharp rise in the unemployment rate triggered by a recession and inflation showing clearer signs of progress by end-2023, we expect the Fed to cut rates by 200bps through mid-2024, approaching a neutral level around 3%.
… We continue to expect three additional 25bp rate hikes in February, March, and May, for a peak funds rate of 5-5.25%. We do not think that Powell meant to send a strong signal about the size of the next hike in February today, but we see his intention to “feel our way” to the appropriate policy rate as most consistent with our forecast of another stepdown in the pace to 25bp.
Asked about the possibility of rate cuts next year, Chair Powell said that the FOMC will only cut when it is confident that inflation is moving down in a sustained way. We are doubtful that the inflation path that we forecast for next year would be enough to provide that confidence…
Goldilocks earlier in the day BEFORE FOMC with an interesting and well-timed REMINDER,
… We see four channels through which this strategy could ease financial conditions. First, a clear desire to change the pace of rate hikes skews the market response to incoming data. Second, forward guidance narrows the distribution of possible rate hikes, which affects forward pricing. Third, strong guidance lowers the volatility of the discount rate, which supports risky assets. Finally, somewhat less data-dependent guidance can reveal something about policymakers’ reaction function or tolerance for current conditions.
Our US economics team has long argued that the US economy responds more to financial conditions than the policy rate, so the recent easing in financial conditions could ultimately prove counterproductive. If policymakers want to keep financial conditions “in check”, they may need at least to put markets back on a more level playing field by avoiding an indication that another step-down is imminent. However, recent inflation news could be reassuring enough for the Fed to stick to its recent strategy. In this scenario, we would expect the Dollar downtrend to continue, against our standing forecast for a stronger Dollar over the near term.
The FOMC delivered a 50bp rate hike, and we continue to look for a final 25bp increase in February. A marked slowdown in job gains is key to how long 25bp hikes could persist. Our strategists turn neutral on all their trades, to re-evaluate them in early January.
… It was difficult for us to follow the logic of changes to the SEP and the Chair's comments, both of which appeared inconsistent. In the end, financial conditions moved little despite the quite hawkish delivery, which likely also reflects recency bias given the latest downward surprises to core inflation …
… Our Rates strategists think the hawkish December FOMC sets up markets to reprice higher terminal rates and reduce the pricing of rate cuts – but see that repricing likely in January, and therefore close out of our 2s5s10s butterfly and SFRM3Z4 steepeners. They look to reevaluate the trades in early January.
The FOMC raised its policy rate 50bp and continued to deliver a hawkish message, as we had expected, indicating that it remains determined to slow the economy and ease labor market pressures in order to bring the inflation rate sustainably to its 2% target.
ABNAmro reads something of a tough message TO mkts,
The FOMC raised the target range for the fed funds rate by 50bp, to 4.25-4.50%, as was widely expected. It also sent a warning to financial markets that if conditions ease too much, the Fed may have to raise rates even more than it is currently signaling.
A lesson most toddlers learn by age three is that you can't both have your cake and eat your cake. Sadly, it's one that seems to be escaping the grasp of central bankers at the moment. Higher and higher interest rates eventually lead to the disappearance of growth, it's an inevitability and the basic mechanism on which modern monetary policy is built. But yesterday Fed Chair Jerome Powell said the central bank doesn't see a recession coming, at the same time as indicating that the US policy rate might climb above 5% next year (chart below courtesy Tatiana Darie). Traders weren't buying it. By 4 p.m. New York, they were pricing a terminal rate of 4.87%, just 1 basis point higher than a day earlier, which is effectively a bet that the central bank will balk if data shows growth faltering next year. Of course, the situation is much more tricky at the ECB and the BOE, both expected to hike rates by 50 basis points today. But let's see if their commentary is taken with an equally large pinch of salt.
Finally, in what is likely more important consideration as year-end approaching rapidly is that positions and books need to be dealt with and liquidity conditions — not that good in 2022 — are likely to get a tad worse. Bloomberg,
… The final Federal Reserve decision of 2022 went off rather smoothly. Equities sold off with some alarm at the 5.1% terminal rate in the dot plots, but they soon pared the move as Chairman Jerome Powell said he thinks settings are already close to as restrictive as needed. Bonds had a smaller drop and came back to be little changed on the day, and the same goes for major currencies.
The mood is calmer than it was just a few weeks ago, even as the Fed completes arguably the steepest year of US tightening on record. The cash rate is up 4.25 percentage points, almost matching the 4.3% added in 1973. Unlike back then, the Fed is also now engaged in quantitative tightening. There are still signs of distress in Treasuries — liquidity is poor and expectations for yield swings remain elevated. Investors will be watching for those gauges to ease a bit lower before they can be sure of a merry Christmas.
