Challenged Outlook
March 3, 2023
–Nice thing about Waller: he’s direct. Here’s the opening line of yesterday’s speech:
Last month we received a barrage of data that has challenged my view in January that the Federal Open Market Committee (FOMC) was making significant progress in moderating economic activity and reducing inflation. I’m not the only one whose outlook has shifted. Since the end of January, financial market participants have revised their outlooks in a way that has led them to mark up their expectations for the federal funds rate at the end of 2023 by about a half percentage point.
He clearly focused on the tight labor market while acknowledging some improvement in inflation. “When the facts change, I change my mind…” From a risk management perspective, I think the Fed fears an inflation backslide more than a sharp drop in economic activity, especially in light of strong labor data. Market sentiment clearly shifted in February, for example on Feb 2, SFRH3/H4 spread was -104 and it settled yesterday +2.5 (9499/9496.5), a swing of over 100 bps representing a revision from significant ease over the year to continued restraint. FFJ3 (April FF) settled 9511, a new recent low. Again, a hike of 25 in March would put the contract at 9517 and a hike of 50 at 9492, so the market keeps grinding a little closer to 50. Yesterday there was a buyer of 40k SFRJ3 9437.5/9425/9412.5p fly for 1.0. Max value would be a mid April price on SFRM3 of 9425. SFRM3 is currently 9459.5 or 5.405. Current EFFR is 4.58. So, as it now stands, SFRM3 is 82.5 higher than the current EFFR. There are FOMC meetings March 22, May 3, June 14 and July 26 which can all impact SFRM3 (of course the July meeting will have muted effect as it’s midway thru the period). For the April put fly to approach middle strike, aggregate tightening perception would be 1-1.25%. 50 in March, 25 May and 25 in June? Certainly not out of the question at this point. Perhaps a better play was the buyer of SFRM3 9450/9437.5ps vs 9487.5c for 0.75…of course, there’s open ended upside risk with the short call.
–All treasuries ended over 4% yesterday, with 2s 4.902% (+1.7 on the day) and 30s 4.02 (+7.1). Note that it was a bear steepener. Tightening is already significantly priced in the front end, but imagine for second if tens and thirties jump another 50 to 75. In 2006-2007 all yields topped around 5.15 to 5.25. The ten year ended yesterday at 4.07. A rapid shift higher in long rates would cause serious dislocations.
–Conventional thirty-year fixed mortgage said to be 7.1%. Today’s news includes ISM Services expected 54.5 from 55.2 last.
