Markets expect CBs to be more aggressive
December 20, 2023
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–Relatively quiet day in US rates, with slightly lower yields. Tens ended at 3.92%, down 3.4 bps on the day. Later in the session Bostic said inflation is probably going to come down slowly in the next six months, and penciled in two rate cuts in H2 of 2024.
UK inflation was released this morning at 3.9%, a large drop but still double the BOEs 2% target. Attached is a chart from BBC. The Fed’s preferred measure of prices is released Friday, with PCE expected 2.8% and Core 3.3% yoy, both down 0.2 from the previous month.
–Central banks maintain that rate cuts are likely to be drawn out, but it’s sort of interesting to compare market expectations across western CBs as shown by short-end calendar spreads. At yesterday’s settlements:
SFRH4/SFRH5 -146.0 (USA)
SFIH4/SFIH5 -148.0 (UK)
ERH4/ERH5 -147.0 (eurozone)
These spreads display remarkable agreement and appear to indicate that CBs will be forced into easing more rapidly than they expect. And if easing ACTUALLY moves forward rapidly, then short-end curves will likely steepen from reds back. A couple of trades in SOFR yesterday reflect that view:
Synthetic long SOFR calendars:
+0QM4 9700/9800cs vs -3QM4 9700/9800cs
SFRM5 9661.0s 24.75/6.00 => 18.75
SFRM7 9669.5s 21.50/3.75 => 17.75
paid 0.5 to 0.75 for 9k
I posted a chart related to this one on X yesterday:
https://twitter.com/AlexManzara/status/1737151032252141602
Also:
+SFRU4 9650/9800cs vs 2QU4 9700/9737.5cs
SFRU4 9576.0s 21.00/4.75 => 16.25
SFRU6 9674.0s 30.75/19.0 => 11.75
paid 4.5 for 20k
This trade requires a bit more urgency to rate cuts (perhaps a rhyme of March’s regional banking crisis). Lower strike of front Sept call spread is 74 otm while the green Sept midcurve is only 26 away.
Note that all SOFR contracts from SFRU5 to SFRU7 are between 9676 and 9667.5. A reasonable conclusion is that easing is expected to be completed by the end of 2025, and then we’ll just hang around between 3.0-3.5%. SFRZ5 is currently the peak contract at 9676.
