For now, higher for longer has the upper hand
Feb 26, 2024
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–Friday featured further curve inversion from reds back as easing expectations are squeezed out of near term pricing. 2/10 treasury spread fell to a new recent low -43 bps (-4.2 on the day). In 2023, 2/10 has a range from -108 to -16. In 2024 the high is -16.5 and the low for the year is right here. On the SOFR curve the red/green pack spread range in 2024 is +1.6 on 16-Jan to -26.25, Friday settle. Low in December’23 was -35. Low in Sept -57, Low in June -63.25.
–A large trade Friday was a buyer of 35k SFRZ4 9450/9437.5/9412.5/9400p condor for 1.0 covered 9544 to 9548. So net premium was less than 1. Obviously, this trade needs the Fed to re-start the tightening process. Note that the top put spread, 9450/9437.5 settled 1.5 vs 9551. SFRZ4 9300p settled 1.75.
–A friend (thanks JK) highlighted an interesting post by Jim Bianco, responding to Mark Zandi. Zandi says the Fed should cut, because stable inflation & employment have been achieved and FF at “…5.5% is difficult to justify, as it is 3 pct higher than the Fed’s own estimate of r-star.” Bianco responds that BofA’s Global Financial Stress Indicator shows the LEAST stress in 4 years. “In other words, 5.50% is NOT a stressful rate. The Global Financial Stress Indicator above says markets are enjoying the least amount of stress at any time in the last four years. — Restated bluntly, a 5.5% funds rate is not restraining anything. So, cuts are not necessary.”
–Dudley’s inputs for financial conditions were: long and short term rates, the value of USD, equity prices, credit spreads. Obviously financial conditions are NOT the same as financial stress. Clearly financial conditions re: FF have been constant since July, but the 10y yield is down 75 bps from October’s high. DXY hit a peak near 115 in 2022, was 107 in Oct and is now 104. Big cap tech as a proxy for stocks have soared. Credit spreads are at pre-pandemic low levels. In general conditions are easier than they were.
–I suppose Zandi could have re-stated to say real rates are high and restrictive, there’s a lot of debt that needs to be rolled, consumers appear to be pulling back and employment is likely to weaken, so modest cuts can be justified. Low financial stress now can turn fairly rapidly into tomorrow’s pain, as was seen in 2001. The snapshots presented by both Zandi and Bianco don’t really capture how the rest of the film might play out, but they do capture the core opposing viewpoints of the market.
