The Fed is likely done
October 10, 2023
–Stocks shook off early weakness related to horrors in Israel/Gaza with SPX +0.6%. XLE (energy etf) gained 2.9%. ITA (defense) +4.45%. Individual names like Genl Dynamics soared even higher, +8.4%. Comments by both Dallas Fed President Logan and Gov. Jefferson indicated that tighter credit conditions and higher long-term rates may mean the Fed is done with short term tightening. FFX3 rose 4.5 bps to 9464 or 5.36%, just 3 bps higher than EFFR of 5.33% so around 12% chance of a Nov 1 hike. SFRZ3 rose 5.5 bps to 9458.5. SFRZ3 9475c settled 5.25 but traded as high as 6.0 late with futures printing 59. (This strike has the most Open Int of any SOFR call).
–Logan focused on term premium in the long end and the tightening of financial conditions (highlighted):
…in setting the stance of monetary policy, the FOMC needs to account for how that stance will translate to the broader financial conditions, including long-term rates as well as credit spreads and other factors, that influence economic activity…
Financial conditions tightened substantially in recent months. Much of the tightening came from movements in longer-term interest rates. Higher long-term interest rates have also contributed to equity price declines and dollar appreciation over recent months.
–Jefferson said he was mindful that the cumulative effect of past rate increases have not been felt, and said the Fed can proceed carefully amid a better risk balance, and will keep in mind the tightening impact of higher long-maturity yields.
–Implied vol in SOFR futures exploded higher with many straddles up 3 to 6 bps (partially due to the shift to higher strikes). For example, on Friday, SFRU4 9512.5^ settled 1.01 ref 9509.0. Yesterday the contract was up 16.5 to 9525.5. The 9512.5^ settled 105.0 and the 9525^ settled 107.5 (from 104.5).
–3yr auction today. Early, we get NFIB Small Business Optimism which was 91.3 last, expected 91.0. The low this year is 89.0 which was the lowest level since 2013. To put it in context, the Covid low in 2020 was 90.9 (about where we are now) and the high in late 2020 was 104. I think it could come in sub-89.
