He thinks I don’t know the ten-dollar words
May 25, 2022
–Brainard speaks today at 11:15 (Commencement address at Johns Hopkins University). The two-year note plunged in yield yesterday, falling over 14 bps coinciding with yesterday’s auction. Red euro$’s rallied 14.75; the curve steepened as longer maturity yields didn’t decline quite as much, but the ten year note still dropped 10 bps to 2.758%. It’s almost as if the market already knows that Brainard is going to advance Bostic’s suggestion of a possible pause after the June and July hikes. Aug Fed Funds (FFQ2) which captures the June and July meetings, settled yesterday at 9816.5 or 1.835%. Given the current 83 bp Fed Effective rate, two half point increases will take EFFR up to 183 by late July…that’s exactly what FFQ2 is pricing. Looking out a bit farther, FFF3 (Jan FF) is 9734 or 2.66%. So from the start of August through the end of this year, the market is loosely looking at 83 bps more. I say “loosely” because short-end moves of 10 bps have become commonplace and sentiment is like a feather blowing on the wind.
–What to say about Bill Ackman? Sort of reminds me of my favorite Ernest Hemingway quote, “Poor Faulkner. Does he really think big emotions come from big words?” Ackman argues that the Fed needs to be much more aggressive, that equity values are determined by the present value of long-term cash flows discounted by long-term rates, and thus, if the latter are repressed by the Fed righteously crushing inflation, stocks will be just fine. Poor Ackman. The reason long end yields will go down is partially because of the Fed addressing inflation, but partially because a stranglehold created by high short-term financing rates will also crush the economy…there’s not going to be much in the way of earnings to discount.
–Not only that, the market does not think the Fed is going to follow Ackman’s prescription. Let’s look at the second half of next year, as informed by the July’23/Jan’24 FF spread. In December, this spread was 45, indicating two 25 bp hikes over that time frame. Pretty modest right? Fast forward to today and the spread is negative 21. So now the market is looking for an EASE in the second half of next year. While all markets have been rather volatile day-to-day, any idiot can tell that this spread is trending…as asset prices are squeezed lower by long capitulation, this spread has sold off. Perhaps we should think of Lake Mead as “half-full” rather than half empty. Maybe we’ll be able to buy a quaint desert home on the cheap. It’s a ‘dry’ heat, and rolling blackouts keep it interesting.
–For some time, EDM3 has been the lowest contract on the euro$ strip, another sign that peak tightening will be over after the middle of next year. Since April, the range has been 9689 to 9619, the low having occurred on May 4. Yesterday’s settle was 9683.0, so it is testing the upper end of the range. Going into the expiration of the June’2022 contract (there are only 12 trading sessions left) there are several inflation indicators. On Friday, Core PCE yoy prices expected 4.9% from 5.2% and U of Mich survey is also released (final for May). The following week has ISM Mfg and prices on Wednesday and the employment report on Friday (wages). On Friday June 10, CPI is released, the same day as June midcurve expiration. EDM2 final settle is June 13.
