Let’s Get Moving!
August 25, 2024 – Weekly Comment
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In the image below, that first guy, the one with the white hard-hat and the clipboard? That’s the interest rate futures market. The second guy that’s tagging along? That’s Powell. The pile of rocks is job losses and slowing growth, with the consumer getting buried.
First guy: “Look Jay, like I told you before, we’re going to have to use the front-loader to move these rocks. Get in there and start shoveling!” JP, “Can it wait for Jackson Hole?”
The graphical image in the futures market that is saying the same thing is the 6-month SOFR futures spread, SFRU4 to SFRH5. As can be seen on the chart below (which is only a six-mo range) in just three months from late May to Friday, the calendar imploded from -36.5 to a NEW LOW of -120.5. On May 29, SFRU4 was 9478.5 and H5 was 9515.5. Friday’s settles were 9509.5 and 9630.0. The current SOFR rate is 5.31 to 5.35. The rate on SFRH5 (ignoring compounding) is 3.70%, around 1- 5/8% lower than the current SOFRRATE. That’s a lot of easing front-loaded into a six month period.
In his Jackson Hole speech Powell said, “The time has come for policy to adjust.” The SOFR futures calendars have increasingly been telegraphing that message, which Powell has now overtly blessed. He stressed concerns about labor conditions as opposed to inflation. Fire up the Komatsu. (We bought it back in June as it became apparent we’d need it, when $/yen was 157).
In an interview Thursday, following the BLS downward revision of -818k from the originally reported payroll numbers, KC Fed President Schmid shrugged off the massive miss, and said it didn’t really change the broad strokes of his outlook. He deemed the labor market as relatively strong.
On the chart above, I note the last three NFP releases. There is clear deterioration, accentuated by lower revisions of the data in both June and July. The new narrative is that illegal immigrants are adding to jobs through “under-the-table” arrangements, so payrolls are being under-counted. I suspect it’s pretty tough for a company of any size to pay cash to employees with no benefits. Is it worth the risk? My guess is that the undercount is not relevant with respect to trend. And if I’m wrong, using lower cost labor is clearly deflationary.
The chart below shows the same SOFR spread on a rolling basis, along with the greenback (DXY). So, while the spread is currently represented by SFRU4 to SFRH5, before mid-June it was SFRM4 to SFRZ4, etc. Over the admittedly short time frame of the past year, the spread and DXY are well correlated. Both DXY and the calendar made new lows Friday. DXY has plunged from 106.05 to 100.72 just since the end of June, though $/yen at 144.37 hasn’t quite taken out the early Aug low of 144.18.
Takeaways from the above are 1) there is currently a LOT priced for near-term easing. 2) following expected aggressive easing, the rate of change slows significantly. While U4/H5 is -120.5, the next 6-mo spread, H5/U5 is -48, and then U5/H6 is -16. 3) if easing is currently being priced too enthusiastically, the dollar will likely stop declining. 4) markets are quite volatile.
The most important news of this week will likely be PCE prices on Friday. Q2 GDP revision is Thursday. On a yoy basis, both PCE prices and Core are expected to be 1/10th higher than last, at 2.6% and 2.7%. Keep in mind, the payroll data has now become more important. Next NFP is 5-Sept. Currently expected 155k. If one has a conspiratorial bent with respect to data massaging, this report will be a big one.
Note that Oct FF settled 9501, up just 2.5 bps on the week. Current Fed Effective is 5.33%. A cut of 25 is 5.08% (9492) and a cut of 50 is 4.83% (9517). The midpoint is 9504.5, so the market leans slightly towards just 25 at the September 18 FOMC. (Btw, on Aug 5, FFV4 settled exactly at 9517). Payrolls will likely be a deciding factor. April 2025 is a “clean” FF contract in that there is no FOMC in that month. Similar in price to SFRH5 it’s 9628 or 3.72%. Obviously FFJ5 will adjust like any other contract to NFP. But just for fun, let’s say the Fed only goes 25 in Sept, but FFJ5 remains around its current price. That would mean FFV4 settle 9492 with FFJ5 still 9628, a difference of 136 bps. There are four FOMCs in that period: 7-Nov, 18-Dec, 29-Jan and 19-March. Fifty bp cuts are coming. But if you think the max move by the Fed will be increments of only 25, then FFJ5 is too damn high! Same with SFRH5.
| 8/16/2024 | 8/23/2024 | chg | ||
| UST 2Y | 406.2 | 391.0 | -15.2 | wi 387.3 |
| UST 5Y | 376.2 | 364.7 | -11.5 | wi 3.623 |
| UST 10Y | 389.0 | 379.9 | -9.1 | |
| UST 30Y | 415.1 | 410.1 | -5.0 | |
| GERM 2Y | 243.3 | 237.4 | -5.9 | |
| GERM 10Y | 224.7 | 222.5 | -2.2 | |
| JPN 20Y | 169.0 | 170.1 | 1.1 | |
| CHINA 10Y | 219.0 | 215.5 | -3.5 | |
| SOFR U4/U5 | -155.5 | -168.5 | -13.0 | |
| SOFR U5/U6 | -22.0 | -19.0 | 3.0 | |
| SOFR U6/U7 | 3.0 | 7.0 | 4.0 | |
| EUR | 110.20 | 112.11 | 1.91 | |
| CRUDE (CLV4) | 75.54 | 75.54 | 0.00 | |
| SPX | 5557.74 | 5634.61 | 76.87 | 1.4% |
| VIX | 14.70 | 15.86 | 1.16 | |
