Dots are rarely right, but they make markets move
March 19, 2025
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–Front SOFR contracts continue to trade heavy in front of today’s FOMC, with SFRM5 and U5 both settling -1.5 at 9587 and 9608, even as every contract one year out and further closed positive on the day. The red SOFR pack (2nd year) +2.75. Greens (3rd) +3.875. Two-yr treasury yield -1.2 bps at 4.038% and tens down 2.3 bps at 4.279%. At 9587, SFRM5 is just 20 bps lower in yield than EFFR (4.33%). The market is paring back ease expectations, according to BBG.
–BBG’s Anna Wong writes this:
Fed staff views on the impact of tariffs have evolved since 2018. During the first Trump administration, staff believed tariffs on intermediate goods – the majority of US imports – would be deflationary. New research shows Fed staff now believe tariffs on intermediate goods will have a persistent inflationary impact on the PCE deflator.
The latest research implies Fed staff could boost their PCE inflation outlook by about 0.5 percentage point for this year, and 0.2 ppt for both 2026 and 2027, at this meeting or a later one.
–Today, we get a fresh round of Fed dots. The clip above tends to dovetail with surveys on inflation expectations which have recently jumped. However, market measures aren’t saying the same thing, with the ten-year breakeven at a recent low of 230 bps. Here’s how the Fed’s estimates changed from September to December (the last SEP). Inflation estimates for end-of-2025 were marked higher, and so was the FF target.
(End-of-2025)
PCE Inflation 2.1 to 2.5%
Core PCE Infl 2.1 to 2.5%
Fed Funds 3.4 to 3.9%
GDP 2.0 to 2.1%
The inflation dots will, in my opinion, either remain the same or come down by 1 tenth. I am not buying into Anna Wong’s piece.
The FF estimate will likely reflect one more ease, from 3.9% (a target of 3.75-4%) to 3.6% (a target of 3.5 to 3.75%).
GDP will likely be revised lower. Atlanta Fed’s GDP Now for Q1 is currently -1.8%. We’re nearly at the end of Q1, and Atlanta is pretty accurate.
–I haven’t read other analyses of the dot plot. It seems to me that if the Fed wants to reassure the market that inflation (and expectations) are not going up, then inflation estimates will definitely not go up (as Anna Wong’s piece suggests). It’s my belief that the Fed is now shifting emphasis to jobs rather than inflation. If we were to get inflation projections to 2.4% and FF 3.625% middle, it would imply neutral at 1.25%. Low in my opinion, but not completely out of the ballpark. If inflation estimates go UP by a few tenths, an already vulnerable stock market will NOT like it. There are a lot of anecdotal reports about economic deterioration, like this from @Barchart yesterday:
“42% of mortgage refinance applications are being rejected, the highest rate in AT LEAST the last 12 years”
–There was a flurry of TY vol buying midday, which suggests to me that vols will hold here:
TYM5 108.0/113.0 strangle vs 110-19 with 5 delta, 45 paid for 9k (settled 46, 30c and 16p vs 110-255)
TYM5 107.5/113.5 strangle vs 110-185 with 5d, 35 paid 15k (settled 36, 24c and 12p)
TYK5 112c 25 paid vs 110-18, 28d for 5k.
All appear new. Perhaps a hedge for unexpected geopol events.
