Stretching it out
August 18, 2022
–US rates ended higher Wednesday with tens up 7 bps to 2.893%. On the euro$ strip, weakness was led by greens (3rd year forward) which were down 13.125. Reds, the second year forward, fell 10.75. The Fed minutes indicated concerns over both inflation and growth, with risks to the latter weighted to the downside. Key lines: “Participants judged that, as the stance of monetary policy tightened further, it would likely become appropriate at some point to slow the pace of policy rate increases while assessing the effects of cumulative policy adjustments on economic activity and inflation. Some participants indicated that, once the policy rate had reached a sufficiently restrictive level, it would be appropriate to maintain that level for some time to ensure that inflation was firmly on a path back to 2 percent.” I.e. stretch out the front-load.
This section would suggest that easing reflected in the euro$ curve in late 2023 and 2024 is misguided (as Kashkari articulated this week). In fact, near calendar spreads rallied in sympathy with that idea. New highs in some spreads Wednesday, with EDU2/U3 settling 34.25, up 9.75 on the day, and EDZ2/EDZ3 -42.0, up 8 on the day. SFRZ2/Z3 settled -31.5. If the Fed is currently neutral, but needs to move to restrictive and then maintain, it would suggest that all ED prices from 6 months out to about 2 years would be nearly the same price. That is, Dec/Dec and March/March calendars should move from negative levels toward zero. Obviously we’re not currently priced that way; the market’s assessment of cumulative hikes thus far is that economic activity will deteriorate further over the next year or so and spark a Fed pivot.
–It’s worth noting that going into the June FOMC the EFFR was 83 bps. If the Fed does 50 in Sept, the rate will be 283 bps, a change of 2% in just one quarter. It could easily be argued that the “front-load” has already occurred and further policy actions can be a slow glide.
–News today includes Philly Fed expected -5 from -12.3 and Jobless Claims, 264k from 262k. Existing Home Sales for July expected 4.87m from 5.12m. July was the worst of the mortgage rate sticker-shock. According to the St Louis Fed website the high rate on the 30y fixed was 5.8% at the end of June, it has now fallen back to 5.25%.
A couple of excerpts from minutes:
In their assessment of the policy outlook, market participants expected significant policy tightening in coming meetings as the Committee continued to respond to the current elevated level of inflation. Nearly all respondents to the Desk survey anticipated a 75 basis point increase in the target range at the current meeting, and most expected a 50 basis point increase in September to follow. The market-implied path of the federal funds rate indicated a peak policy rate of around 3.4 percent, significantly lower than at the time of the June meeting.
Staff Economic Outlook
The projection for U.S. economic activity prepared by the staff for the July FOMC meeting was noticeably weaker than the June forecast, reflecting the economy’s reduced momentum and current and prospective financial conditions that were expected to provide less support to aggregate demand growth.
Participants judged that, as the stance of monetary policy tightened further, it likely would become appropriate at some point to slow the pace of policy rate increases while assessing the effects of cumulative policy adjustments on economic activity and inflation. Some participants indicated that, once the policy rate had reached a sufficiently restrictive level, it likely would be appropriate to maintain that level for some time to ensure that inflation was firmly on a path back to 2 percent.
