Pushing the ease forward
June 13, 2024
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–Better than expected inflation news as month/month CPI was 0%. On a yoy basis, headline 3.3% and Core 3.4%. The FOMC dots shifted to just one ease into the end of this year with the estimate for FF at 5.1% from 4.6% in March. The projection for 2025 was also raised to 4.1% from 3.9%. In the press conference Powell stressed risks in trying to thread the needle between holding policy rates high for too long and easing too soon. The Core PCE inflation estimates were raised to 2.8% from 2.6% in 2024 and 2.3% from 2.2% in 2025. In terms of a ‘real’ rate, 5.1% vs 2.8% Core PCE is 2.3% for 2024 and 4.1% vs 2.3% is 1.8% for 2025, so the Fed expects to remain relatively restrictive for the foreseeable future.
–Market reaction included new lows in near SOFR 1-year calendar spreads. The lowest spread is now U4/U5 at -104 (9484.5/9588.5) down 10 on the day. Reds, the second year forward, were the strongest contracts on the strip as the Fed masterfully keeps moving the easing goalposts a little farther away in time. (Whites +4.625, reds +13.375, greens +13.5, blues +11.75) Stocks exploded higher. Implied vol in near SOFR contracts was hammered. For example, on Tuesday SFRU4 9481.25^ settled 18.25 and yesterday at 15.0. While the dots project one ease into year-end, FFF5 settled +6 at 9512.5 or 4.875%, which is 45.5 bps under the current EFFR. The market is still leaning toward the idea of two eases.
–I would note that in the March SEP, the FF projection difference between 2024 and 2025 was 75 bps (4.6 and 3.9). Now the difference is 100 bps, (5.1 and 4.1) which, in a way supports the deeper inversion between fronts and reds. Z4/Z5 settled at a new recent low -91, down 8 on the day (9513/9604).
–The March FOMC was on 3/20. At that time, Dec contract settles vs FF projections were as follow:
SFRZ4 9551.5 or 4.485% vs FF projection at 4.625%, so Z4 had an additional 14 bps of ease priced
SFRZ5 9624.0 or 3.760% vs FF projection at 3.875%, so Z5 had an additional 11.5 bps of ease
SFRZ6 9633.5 or 3.665% vs FF projection at 3.125%. So Z6 was 54 bps HIGHER than the Fed projection
Yesterday
SFRZ4 9513.0 or 4.870% vs FF projection at 5.125%, so Z4 had an additional 25.5 bps of ease priced
SFRZ5 9604.0 or 3.960% vs FF projection at 4.125%, so Z5 had an additional 16.5 bps of ease
SFRZ6 9630.5 or 3.695% vs FF projection at 3.125%. So Z6 was 57 bps HIGHER than the Fed projection
It seems as if the market believes that inflation will remain durably higher over the next few years and that forward rates over the next few years are likely capped between 3 and 3.5%.
–PPI and 30 yr auction today.
