weekly observations (11.25.24): "Fixed income funds are still underweight duration vs the benchmark", '25 inflation boom & more #2025 dart-throwing contestants
Good morning / afternoon / evening - please choose whichever one which best describes when ever it may be that YOU are stumbling across this weekends note…
First UP, the news which will likely impact markets positively when they open up Sunday evening …
Bloomberg: Trump Nominates Hedge Fund Chief Bessent to Lead US Treasury
Bloomberg: US Treasury Pick Bessent ‘Is a Fiscal Hawk’: Wall Street Reacts
US Treasury market is closed until Monday morning in Asia
Trump nominated hedge fund chief as Treasury Secretary Friday
CNBC: Donald Trump chooses hedge fund executive Scott Bessent for Treasury secretary
WSJ: Trump Picks Scott Bessent as Treasury Secretary
ZH: Trump Names Billionaire Scott Bessent As Treasury Secretary
… lets see …
And now, a couple visuals of rates on my mind as we head into holiday shortened week with supply front-loaded and $69bb of 2s up Monday …
2yy: psychologically important (?) 4.375% just above recent TLINE (trend is yer friend ‘til it bends) …
… as momentum on WEEKLY basis has become overSOLD and while not yet rolling over signalling a BUY, certainly would seem to be worth watching this weeks auction as many — brightest bulb in the room, BMO below — notes front end trading now where FF are soon to be (and so, current levels almost wearing a ‘soft cap’?) and others point out underweight relative to benchmarks …
… AND here’s a weekly look at 10s since i’ve been out of my front-row seat …
10yy WEEKLY: unable to press above 4.50%, psychologically important AND coinciding with TLINE of some interest …
… as momentum appearing overSOLD … positions and all, things set to become MORE funTERtaining …
I may NOT like bonds because I may think inflation has NOT been conquered (some detailing below, believe 2025 we transition to an ‘inflation boom’ which will lead to ANOTHER negative year for bonds) and the economy may NOT be falling into significant recession.
I listen to price action as much, if not more, than data and Global Walls research notes.
In PRICE there is truth and frankly, it tends to lead the narrative creation machine and it would seem to ME that bonds have priced in lots of the good and the ‘flation and may be set to perform …
Maybe think RENT TO OWN, not going all IN?
Clearly the front-end (2s) going to need some assistance from the Fed (so, NO Santa Pause?) OR perhaps, just some time at a price required and will be refreshing because, if you think rates are coming down, then owning 2s here / now isn’t really rocket science.
It’s not IF you are going to be right and make money, it’s about how long it might take? More on this below (BMO, specifically) …
NOW lets deal with a couple / few things items from the week just passed (in other words, a couple snarky ZH links which contain visuals and info graphics helping tell the tale of markets — INCLUDING rates — which you may / may not have already stumbled upon) …
Hope, they say, springs eternally and so …
ZH: Trump 'Hope' Sends US Services PMI Soaring To 32-Month High
… this hope in context of the exact opposite over in the EZ yest … but then, hope (in at least some corners of the country) was crushed …
ZH: UMich Inflation Expectations Jump To 16-Year-High, Democrats' Confidence Crushed
… and speaking of crushed, Global Wall contemplates good as bad … again …
ZH: Bitcoin, Gold, & Stocks Surge On Week As 'Good' Data Wrecks Rate-Cut Hopes
… Solid economic performance is sparking a massive rethink of Fed rate-cut expectations (which is of course not political at all), with a 50-50 chance of 2 or 3 cuts by the end of 2025 now...
… and so, rate CUT HOPES and dreams are clearly at risk …
… Ok I’ll move on AND right TO the reason many / most are here … some WEEKLY NARRATIVES — SOME of THE VIEWS you might be able to use … THIS WEEKEND, here a few things which stood out to ME from the inbox …
AND we start with that old saying / thought of a bull in a china shop …
The US economy showed remarkable resilience in the face of very restrictive rates. It is however increasingly showing cracks, with weakening consumption and labour market. Uncertainty about future policy is large, as is the range of potential outcomes…
… and now a visual generated by Gemini …
… AND we’re back from the AI thinking about CUTS but maybe not as fast and / or furious …
In the US, we recommend 2yf2s10s curve steepeners as the market should price in a resumption of the easing cycle, even if the Fed pauses. In Europe, ECB speak puts increased focus on the December meeting. In Japan, we expect term premium to drive 10y yields higher going forward…
…Market implications: Curb your enthusiasm Markets have reacted to the events over the past two months by significantly paring back the depth of the easing cycle. Figure 13 shows that the implied trough of the easing cycle is 3.8% and Figure 14 shows that the markets are pricing in 45% probability that the Fed skips December, with only a touch more than two cuts priced in beyond that. We believe that is too pessimistic of a view of potential economic policy details. We recommend 2yf 2s10s curve steepeners, as the market should price in an eventual lower terminal rate. The trade carries negatively by 1.6bp over the next three months.
A few things of note … …Third, fixed income funds are still underweight duration and they are likely to extend to the intermediate sector given fiscal uncertainties further out the curve. Figure 20 shows the positioning of fixed income funds, which we estimate through a regression of daily relative returns against market moves. As can be seen, they have been somewhat underweight duration versus the benchmark and have room to add duration .
… and with short week just ahead, best in biz still liking front-end (on further dip) …
In the week ahead, the Thanksgiving holiday (and related market closure with Friday’s early close) will leave investors with a truncated schedule for an array of meaningful inputs. Topping the list will be Wednesday’s release of the core-PCE report, which is expected to show a 0.3% monthly gain in the Fed’s preferred measure of inflation. It's tempting to look toward such an outcome as a potentially bond-bearish event, and ostensibly it will be. However, Powell has already addressed the October inflation trajectory and the ‘sometimesbumpy’ path back to the Fed’s 2.0% inflation target. We’re content to take the Chair at face value and assume the firmer core-PCE figures have already been incorporated into the Committee’s recent guidance. To be fair, there's been mixed messaging as to the timing of a potential pause. One might interpret Powell's thoughts on the pace of normalization as preparing investors for a December pause, although we suspect the Fed is simply laying the groundwork for skipping a meeting in the first quarter of 2025….
…The holiday schedule has shifted forward the upcoming auctions – with Monday’s 2-year sale kicking off the final coupon supply series of November, which also includes Tuesday’s 5-year offering and Wednesday’s 7-year tender. The front-end-heavy auctions have at least been a marginal limiting factor for a steeper yield curve, and we’ll be eager to see whether the process of absorbing 2s and 5s will free up the 2s/10s and 5s/30s curves to steepen into what will effectively be a four-day weekend for many. The two complicating factors working against a steeper curve will be the looming month-end demand and the ongoing geopolitical tensions…
… Living History II: US Treasuries on course for 3rd loss in 4 years in 2024…1st time since 1955-58 (Table 1); note Treasury returns were again negative in 1959 as US economy boomed/budget deficit rose, i.e. bond returns can fall in 4 out of 5 years.
The Biggest Picture: BofA Investment Clock says equity-bullish “recovery” phase of lower rates and higher EPS (2024) to be followed by commodity-bullish “boom” phase of higher EPS and higher rates; “bear steepening” of yield curve in ’25 signals transition as bonds price-in “inflation boom” and price-out rate “cuts,” signals bond yield levels that cap risk assets in early ‘25 (real rates >2.5%, long rates >5%, short rates >4.5%).
… AND to France trying to predict the unpredictable …
BNP: US economy: Predicting the unpredictable under Trump
KEY MESSAGES
We think President-elect Trump should be taken both seriously and literally. Accordingly, it seems time to add the core of his anticipated economic program to our US baseline.
We see higher tariffs, on both China and the rest of the world. We also expect fewer net new immigrant arrivals.
Inflation will likely be considerably higher, and growth lower, once tariffs take effect.
We think the Fed will maintain tighter policy as a result.
…Can the Fed look through tariff-related inflation? In 2018, the FOMC studied internally the macroeconomic effects of a rise in tariffs, which the first Trump administration was considering then. The Fed staff found that the inflationary impact of tariffs could be safely looked through, as they were non-recurring, not tied to the business cycle, and short run in nature. Importantly, the impact depended on long-term inflation expectations remaining stable: if consumers reacted to tariffs by expecting permanently higher inflation, this would require the FOMC to act.
We think these expectations are much less stable today than they were in 2018, due to the recent experience with high inflation during the pandemic-recovery period. The FOMC also probably largely feels uneasy about the longterm inflation expectations, with Powell making seemingly hawkish comments in his recent Dallas Q&A and distancing himself from the 2018 study. As a result, we expect the FOMC to react to tariff-led inflation similar to how it did to Covid-led inflation. It is possible, although much less likely, that the FOMC may need to react more forcefully, even with hikes, should the FOMC believe these expectations are loosening…
…We believe Powell is aware of the risks that a period of successive positive inflation shocks entail and would react to demonstrate firm commitment to the FOMC’s 2% inflation target.
… a large German operation looking at and noting record net spec short 5s (which then may bode very well for Tuesdays liquidity event) …
Summary The global economy has shown remarkable resilience in bouncing back from supply chain disruptions during a pandemic, an energy and food crisis as the Russia-Ukraine war began, high inflation and consequent monetary policy tightening. Most G-20 economies will experience steady growth and continue to benefit from policy easing and supportive commodity prices. However, postelection changes in US (Aaa negative) domestic and international policies could potentially accelerate global economic fragmentation, complicating ongoing stabilization. The aggregate and net effects of trade, fiscal, immigration and regulatory policy changes will expand the range of outcomes for countries and sectors.
G-20 economies will post steady but differentiated growth rates. We forecast the G-20 economies will grow by 2.8% in 2024, down from 3.0% in 2023 and moderate through 2026. The US economy is outperforming other advanced economies, though its growth will likely decelerate despite the strong momentum. Europe's sluggish recovery will gradually firm. China 's (A1 negative) growth will likely slow even as stimulus measures are implemented. Rising trade protectionism and a push in several large economies to strengthen domestic industries makes external demand a less reliable source of growth.
Increased trade tensions and geopolitical stresses are primary risks to the macro outlook. The inclusion of North Korean soldiers by Russia in Ukraine (Ca stable), rising tensions in the South China Sea and the Taiwan Strait and expanding conflicts in the Middle East contribute to a tense international backdrop. Competition between the US and China will shape policies, potentially raise global trade barriers and trigger trade or currency wars. This long-term geoeconomic fragmentation could further split the global economy into geopolitical blocs, complicating global trade and financial connectedness, further dampening global growth.
Reductions in global policy interest rates will end in 2025. We expect core inflation will decline to near central bank targets by mid-2025, facilitating movement of policy rates toward neutral stances. Synchronized easing will help bolster economic stability but at least some of this may be countered by heightened risks to US inflation from policies proposed by the incoming administration of Donald Trump. We expect the Fed will adopt a cautious approach to policy normalization.
Change in US administration injects greater policy induced uncertainty. The new US administration will inherit an economy with surprising strength but for forecasting purposes we assume that the net effect of policies will exert a small drag on economic activity. Other than that, we do not account for changes to fiscal, immigration or trade policies until they are implemented.
… There is considerable uncertainty about the equilibrium level of the US neutral rate, as reflected in the wide range of estimates of long-term nominal federal funds rates included in the Federal Open Market Committee's September Summary of Economic Projections, which ranged from 2.4% to 3.8%. We assess the fed funds rate will eventually normalize to somewhere in the range of 3.0% and 3.5% (see Exhibits 7 and 8).
…EXHIBIT 8 Bond yields are set to remain high 10-year government bond yields, %
… a large domestic shop with a Friday recap of 2025 outlooks …
MS: Friday Finish – US Economics: Year-Ahead Outlook Recap
Over the next two years, we expect lower immigration flows and more tariffs to slow GDP growth and make inflation stickier. Inflationary pressures and policy uncertainty spark greater Fed caution, leading to a pause in 2Q. Rate cuts resume in 2H26 as higher tariffs hit growth and job gains almost stop…
…Against this backdrop, we expect a slightly higher terminal rate in 2025 but more cuts in 2026 due to lower growth. Higher sequential inflation in 1H25 and overall uncertainty about the inflationary effect of new policies make the Fed pause earlier than our previous forecast. We now expect 25bp cuts at the next four meetings, bringing the fed funds rate to 3.625% by May 2025 (we had expected cuts through June). Tight immigration policy and deportations imply lower potential GDP or production capacity, so the Fed must restrict demand to conform to the lower level of supply. In 2026, once the push to inflation from tariffs fades and the drag on activity becomes clear, the Fed cuts faster, taking rates below neutral.
… AND speaking of 2025 …
MS: 2025 Global Macro Strategy Outlook: The Order of Operations
In 2025, macro markets focus on an order of operations different to the one most learned in school: that of the incoming US government's actions along three policy axes: fiscal, immigration, and trade. A dovish skew to G10 central bank policy rates colors our view for lower G10 rates and a lower DXY.
Key takeaways
G10 rates: We expect Treasury yields to decline as the Fed cuts more than what is priced into markets, and the story is similar in Europe and the UK. Potential downside risks to growth from trade and immigration reforms mean that the US front end will likely be biased lower and the Treasury curve bull steepens.
G10 FX: US tariffs and risk premium associated with trade and geopolitical tension are USD-positive, leading the greenback higher into end-2024. But falling real rates should reverse USD strength in 2025. JPY and AUD are the top G10 performers while EUR lags on crosses on weak euro area growth.
…Interest Rate Strategy United States UST base/bear/bull forecasts:In the base case for Treasuries, we expect yields to move lower and the curve to steepen over the forecast horizon, with yields falling more in 1H25 than 2H25. We forecast 10-year yields will reach 3.75% by mid-2025 and ending the year just above 3.50%. In the bear case, we see 10-year yields ending 2025 just above 4.50%, with the 2s10s curve returning to a modestly inverted -15bp. The bull case sees 10-year yields bottoming in 3Q25 at 2.05% as significant Fed cuts feed into rates.
US Treasuries to outperform swaps:We expect Treasuries to outperform swaps throughout 2025. This comes as investors speculate on bank balance sheet capacity improving, allowing more bank demand and intermediation, and our models show tightening pressure abating based on the evolution on PD holdings and the SOMA portfolio.
US Treasury supply outlook: We think a sentiment sea change about Treasury supply is set to take place. The end of QT will alleviate a significant burden from Treasury's financing needs while an optimal bill share of total outstanding debt “averaging around 20% over time” affords Treasury flexibility in its debt management practices, even in consideration of a higher deficit path. Uncertainty on timing of the debt limit resolution as well as the output from DOGE's consultation on spending means no coupon increases in 2025, in our view.
… same firm with an early NFP precap and victory lap …
Our 270k forecast for November payrolls includes +100k from strike- and storm-affected employment and a stronger underlying pace than in recent months. We also expect upward revisions. The UE rate inches up to 4.2% and AHE rises 0.3%.
…Exhibit 2: We project payrolls rose 270k in November, boosted by the return of 40k in strikers and 60k in storm-affected employment.
… is it early or just me? Moving right along from payrolls and back TO 2025 and this next one comes from a UK shop …
…US rates strategy With the Fed’s easing cycle underway, resilient growth and signs of US exceptionalism have again tempered expectations for a rapid return to a lower rate environment. Moderating inflation towards the Fed’s target has allowed for loosening of monetary policy to offset a natural tightening in real rates, but a resilient labour market and growth is set to reign in the pace and duration of policy rate cuts. A second Trump administration with limited stated plans to address the fiscal deficit and aspirations of America first tariff policies also acts as a significant upside risk to rates, and we expect both a shallower Fed easing cycle and stimulatory fiscal policy to keep rates off their 2024 lows.
In our forecast, the Fed easing cycle continues into the first quarter, allowing a near-term steepening trend to remain intact through that period as the front-end of the Treasury curve gains. We see the easing cycle to be completed by March 2025 with terminal rates at 3.75-4%. This should limit front-end and belly rates, making curve steepness largely a product of stickier long-term rates and rising term premiums. This sets the stage for 2025 to be (another) negative one for US Treasuries and duration.
… AND a large Swiss operation weighing in …
UBS: Year Ahead 2025: Roaring 20s – The next stage
By many measures, markets have had a “roaring 20s” – with five years of strong performance for global equity market indices, technological breakthroughs, and stronger-than-expected US economic growth. As we enter 2025, UBS’s Chief Investment Office looks at key developments that will shape the next stage of this decade, including US political change, transformative innovations, and lower interest rates.
…The report highlights the following investment views for the year ahead:
Position for lower rates: Cash returns are set to diminish in light of further central bank rate cuts. Meanwhile, investment grade bonds offer attractive yields and potential for capital gains, with total expected returns in the mid-single-digit range in USD.
More to go in stocks: 2025 should bring further upside for stock markets. The US is a preferred market, while diversified exposure to Asia ex-Japan could be an effective way to capture potential upside in the region while managing risks. In Europe, Eurozone small- and mid-caps and Swiss high-quality dividend stocks look attractive.
Transformational innovation opportunities: Artificial intelligence and power and resources constitute two opportunities within equities with the potential to provide significant and sustained profit growth, that could earn investors in these areas outsized long-term returns.
Trade the range in the US dollar: The US dollar is likely to be caught between short-term positive drivers, including tight US labor markets and tariffs, and longer-term negatives, including overvaluation . Investors should use periods of strength to reduce US dollar exposure.
Go for gold: Lower interest rates, persistent geopolitical risks, and US government debt concerns should continue to support gold in 2025. There are also long-term opportunities in copper and in other transition metals as demand rises alongside rising investment in power generation, storage, and electric transport.
Time for real estate: The outlook for residential and commercial real estate investments is bright. With constrained supply and rising demand, there are opportunities in sectors including logistics, data centers, and multifamily housing
… Covered wagon folks weighing in attempting to ask / answer the question on our minds …
…Interest Rate Watch: How Much Will the Fed Cut Rates? Strong economic data, recent comments by Fed officials and the potential of higher inflation in 2025 due to tariff increases have led market participants to dial back their expectations of Fed rate cuts in coming months.
Financial market participants have done a complete rethink recently regarding the amount of monetary policy easing they expect from the Federal Reserve in coming months. As recently as midSeptember, when the target range for the federal funds rate stood at 5.25%-5.50%, investors had looked for the FOMC to slash the range to 3.00%-3.25% by the June 18, 2025 policy meeting (chart). This expectation implied 225 bps of Fed rate cuts over a period of roughly nine months. The FOMC has already cut rates by 75 bps since mid-September: 50 bps on September 18 and 25 bps on November 7. If expectations had remained unchanged since mid-September, then investors would still be looking for another 150 bps of policy easing by June 18.
However, market participants have significantly dialed back their expectations for Fed easing by June 18. Specifically, investors now expect only 50 bps of rate cuts by June 18 and a total of about 75 bps by the end of 2025. What changed? There are a few factors that have led to the diminution of expected rate cuts in coming months. First, recent data show that the pace of economic activity remains solid and the journey back to the Fed's inflation target of 2% continues to be painfully slow. Data released on October 30 showed that real GDP grew at a solid annualized rate of 2.8% in Q3-24. A day later, data on the year-over-year rate of core PCE inflation revealed that the Fed's preferred measure of consumer price inflation remained stuck at 2.7% for the third consecutive month in September.
Recent comments by some Federal Reserve officials have also led investors to dial back their expectations of policy easing. Chair Jerome Powell said in a speech on November 14 that “the economy is not sending any signals that we need to be in a hurry to lower rates.” Federal Reserve Governor Michelle Bowman said this week that “I would prefer to proceed cautiously in bringing the policy rate down.”
Furthermore, anticipated policy changes in the wake of the November 5 election likely have contributed to the change in expectations. As we discussed in a report we published on November 6, inflation likely will rebound next year if President-elect Trump imposes sweeping tariffs on America's trading partners, as he repeatedly promised to do during his campaign for the presidency. If inflation does indeed rise again next year— see our recently published Annual Economic Outlook for details—then the FOMC likely will choose not to ease policy significantly.
As of this writing, we look for the FOMC to cut the target range for the federal funds rate by another 25 bps at its next policy meeting on December 18. That said, incoming data in the next few weeks, especially the labor market report for November, which will be released on December 6, and CPI data for the same month, which are on the docket on December 11, will clearly play an important role in determining the Committee's decision on December 18. If nonfarm payrolls are strong and/or CPI inflation comes in hotterthan-expected, then Committee members may decide to take a pass at the December policy meeting. We currently look for the target range to bottom out at 3.50%-3.75% in Q3-2025. Stay tuned.
… AND same shop on 2025
Wells Fargo: 2025 Annual Outlook A New Horizon: The Economic Outlook in a New Leadership and Policy Era
Summary
The economic aftershocks of the COVID pandemic, which have dominated the economic landscape over the past few years, are steadily dissipating. These pandemic-induced economic effects are set to be largely supplanted by economic policy changes that are on the horizon in the United States.
The American president can act largely unilaterally when it comes to changes in trade policy. During his campaign for the presidency, Donald Trump promised to impose a 10% across-the-board tariff on U.S. trading partners with 60% levied on China. Although the magnitude and timing of any actual tariff hikes are uncertain, we expect the Trump administration will indeed impose some levies on American trading partners. By raising consumer prices, tariffs impart a modest stagflationary shock to an economy.
We have bumped up our forecast of inflation for next year, while shaving down our real GDP growth forecast. We still expect the Federal Reserve to ease monetary policy further, but we believe the target range for the federal funds rate will be 50 bps higher at the end of 2025 than we did previously.
Republicans will control both chambers of Congress beginning in the new year. We expect Congress to fully extend the tax cuts that were legislated in the 2017 Tax Cuts and Jobs Act, which are set to expire at the end of 2025. But extension of the tax cuts does not impart fiscal stimulus to the economy, because extension would simply prevent tax rates from reverting to their higher pre-2017 levels. That noted, we expect Congress to legislate some additional tax relief next year, which should help to boost real GDP growth in 2026.
Not only will tariffs weigh on U.S. real GDP growth next year, but economies with significant export exposure to the United States likely will be negatively affected as well. Under our tariff assumptions, we forecast the global economy will grow only 2.5% in 2025, down from 3% in 2024.
We look for a significant amount of monetary easing next year by many major foreign central banks, including the European Central Bank, the Bank of England and the Bank of Canada. As interest rate differentials move in favor of the greenback, we look for the trade-weighted value of the U.S. dollar to rise to its highest level in more than 20 years in the coming quarters.
Moving along and away FROM highly sought after and often paywalled and Global Wall Street narratives TO just one thing from the WWW …
… I see four reasons for a pause. First, there is growing evidence that inflation may be getting stuck above the 2% target. October was another strong month on the inflation front: core CPI rose at a 3.4% annual rate and the components of the PPI that go into the core PCE deflator were strong as well. The chart shows one- and six-month annualized core PCE inflation, including an annualized 3.6% mom estimate for October. The Fed almost declared victory on inflation early this year when the annualized six-month increase fell to 2%. However, since then it is not clear whether inflation is heading back to target or not.
Second, both the economy and financial markets look quite resilient…
…Third, evidence that r-star is higher than the Fed assumes continues to build…
…Finally, release of the new SEP is a natural time to rethink the policy path…
… Santa PAUSE then is comin’ to town??
Now, for any / all (still)interested in trying to plan your trades and trade your plans in / around FUNduhMENTALs, here are a couple economic calendars and LINKS I used when I was closer to and IN ‘the game’.
First, this from the best in the strategy biz is a LINKthru TO this calendar,
