Lags
July 26, 2023
–FOMC today featuring a fully expected hike in FF to 5.25-5.50%. Fed Effective has been 5.08%, should now move to 5.33% and FFQ3 settled 9467.5 or 5.325%. The November FF contract is lowest on the curve and settled 9456 or 5.44%, not quite half-a-hike being priced over the next two meetings (Sept 20 and Nov 1).
–During the late 1990’s dotcom bubble I had a client who was fully loaded up long on speculative names. I expressed my concerns about higher interest rates and he told me it didn’t matter because these companies weren’t borrowing, they were raising funds through equity. Eventually, interest rates ALWAYS matter. At some point investors favor the certainty of high-paying notes rather than equities. It becomes a question of real rates and lags. Real rates are now positive and rising as FF are above all inflation measures. The question of lags has become critical and, in my opinion, will be the most important topic of the press conference. Powell and others have indicated that the Fed’s forward guidance speeds up the economic response and lags aren’t as great anymore. I.e. the economy has fully adjusted for hiking thus far and has easily absorbed recent hikes.
–However, there’s an interesting post on ZH citing Soc Gen’s Albert Edwards who notes that even with significant rate hikes, corporates net interest expense as a percent of profits has actually declined! From the article:
Edwards concludes, a sizeable proportion of the “huge, fixed rate borrowings during 2020/21 still survives on company balance sheets in variable rate deposits (see Z1 table L103)” meaning that corporations continue to benefit from locking in the ultra low rates of 2020 and 2021 even as their cash interest income are soaring. Indeed, as the SocGen strategist adds, “companies have effectively played the yield curve in reverse and become net beneficiaries of higher rates, adding 5% to profits over the last year instead of deducting 10%+ from profits as usual
| “Something Very Strange Has Happened”: Albert Edwards Stunned By “The Maddest Macro Chart I Have Seen In Many Years”ZeroHedge – On a long enough timeline, the survival rate for everyone drops to zerowww.zerohedge.com |
–So, companies locked in long term low rates and now are benefiting. Does it make sense that so many companies saw this coming but regional banks didn’t? I’m not sure of that, but what I do think is that the result would be LONGER and not SHORTER policy lags. Same is true for the lack of housing supply: people who have 30y mortgages locked in at sub-3.5% aren’t selling.
–DoubleLine’s Jeffrey Sherman yesterday said (BBG) “Markets should brace for a deep US recession that warrants a dramatic 1% interest rate cut by the Fed…” Rates matter. Coincidentally, there was a buyer of 10k SFRH4 9575/9675c spread yesterday, settled 9.25 ref H4 9484. Moving to lower strikes; there has already been a buyer of 100k + SFRH4 9600/9700cs.
