Fed Week Arrives

  • With another hawkish FOMC announcement due on Wednesday afternoon, Treasuries are not waiting around as the selling has already begun this morning. The 2yr Treasury is yielding 3.94%, a new cycle high, while the 10yr Treasury is trying to push above 3.50%. It peaked at 3.52% earlier this morning but currently sits at 3.48%. If 3.50% gives way the next line in the sand is 3.59%.

 

  • Equities are joining in the early selling too with the Dow indicated down 230 points as equity investors continue to price in a hard landing, if not an outright recession, as the Fed’s battle with inflation could be tougher and longer lasting.

 

  • The FOMC is expected to hike 75bps with a small chance (20%) of a 100bps hike. We think they do 75bps but that doesn’t mean there won’t be plenty of other bearish news from the meeting. The updated fed funds dot plot and economic forecast will get just as much attention, if not more, as the actual hike does.

 

  • One bit of information investors will be looking for is the Fed’s latest guess as to what the terminal rate will be. In June, the forecast was for a 3.50% – 3.75% level but that’s expected to have a 4-handle now with the market consensus at 4.25% -4.50%. If it comes higher than that expect more selling on the front end. The other information in that regard will be how long the Fed expects to stay at that terminal rate. In June, rate cutes were expected by 2024. If that’s extended in this forecast, it has the potential to push yields higher on the short to intermediate part of the curve.

 

  • The market is still pricing in some rate cuts as early as the second half of 2023, so that is vulnerable if the Fed comes back with something appreciably longer like, 2025. We think they still hang onto a 2024 rate cut forecast, but given the stickiness of inflation, and recent hawkish Fed rhetoric, a 2025 date is certainly in the realm of possibility.

 

  • The economic forecast will also get scrutiny as to whether they forecast a recession, and how high unemployment is expected to reach, along with the path of inflation. In the June forecast, the Fed was basically projecting a soft landing with no recession and limited damage to the labor market and a rather quick return to 2% range inflation. The forecast on Wednesday won’t be as rosy but just how much damage to the economy and how quickly they see inflation receding will be new information for the market and will likely create some trading volatility.

 

  • As to where the 10yr yield may go after the FOMC meeting, we’ve often used the Copper/Gold ratio as one indicator that has usually been pretty reliable (see graph below).  Given the importance of both metals to the economic outlook, and given the slowing global growth expectations, it’s no surprise that the ratio has declined but that hasn’t been followed by lower Treasury yields. At least not yet. Given the close correlation from the past, however, it does seem to point to lower yields, especially if the slowing growth forecast comes to fruition, which does seem likely.

 

 

Copper/Gold Ratio and 10yr Treasury YIeld

Source: Bloomberg


 

Agency Indications — FNMA / FHLMC Callable Rates

Maturity (yrs) 2 Year 3 Year 4 Year 5 Year 10 Year 15 Year
0.25 3.86 3.91 3.89 3.93 3.98 4.44
0.50 3.85 3.88 3.83 3.82 3.84 4.33
1.00 3.84 3.85 3.80 3.75 3.75 4.20
2.00 3.84 3.74 3.65 3.63 NA
3.00 3.59 3.57 NA
4.00 3.52 NA
5.00 3.48 NA
10.00 NA

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Tags: Published: 09/19/22 by Thomas R. Fitzgerald