What a Difference a Year Makes

From the Fall of 2018 through today, this has been one of the largest transformations in market and Fed pricing in the history of financial markets. And similar to the Fall of last year, the latest Fed chatter is speaking with equal conviction now than it did then.

Markets

Global bond markets are showing signs of a larger reversal. We’ve been discussing this scenario along the way: whereas the global macro headwinds for most of the past two years subside, and at the same time the central banks don’t just walk away. 

10-year Forward, 10-year Euro Swap Rate

Source: Bloomberg

Granted, in the US the Fed has paused. Yet even with that pause, perhaps the greatest takeaway from the Powell press conference was the Fed’s commitment and discussion around their quest to hit the 2% inflation target, and letting it sustain at or above this level for a prolonged period of time before tightening.

Global rates will continue to provide support for quite some time. 

All indications continue to point to a Phase 1 deal between Trump and Xi. Beyond that it remains to be seen. And with that, we are mindful of the extreme levels we have been trading at since August of 2019: inverted curves, outright, negative rates- you name it.

Although it’s too early to say the themes of 2019 have been extinguished, the last few days presents the type of price action one would expect if the global manufacturing data begins to improve and the global economy begins to show signs of recovering.

US 10-year yields. We spent a considerable amount of time slightly above 2% in June and July before the August duration grab.

Source: Bloomberg

The broader price action out of the abyss will not come from the consumer. It will come from the place where the major themes of 2019 emanated from: the global landscape and rate structure outside the US.

In fact, we’d go so far as to say we could have a scenario where the global economy recovers, and the consumer slows a bit: the passing of the baton if you will. 

Several months back, we began pointing out both the extremes in Euro rates, and additionally the key levels on the way back out higher. Many of the European benchmark rates are beginning to breakout (higher). Same time, in the US 10-year yields are still within their range trading slightly above 1.90%. We view 1.90% as the upper end of the range for the past few months.

On October 24th, we shared our White Paper on the yield curve: Is It Time for the Yield Curve to Steepen? For those that didn’t see, please visit the AmeriVet Website.

It’s interesting, though, coming out of the Fed meeting:

1) The Fed has capped short end rates for the foreseeable future- inflation needs to hit 2% and stay there for a while. With risks still skewed the other way.

 2) The Fed is buying the short end to increase the overall reserve numbers. Plausible they need to do more not less should the regulators not move on ratios. The Fed would almost certainly keep purchases on the short end & staying away from the QE stigma.

 3) There is progress on the biggest growth headwinds of the last year and a half. Won’t be perfect but matters.

 4) Global central banks are still leaning toward more liquidity, not less.

 5) Always possible Fed needs to ease more in 2020. Our baseline call.

6) All things considered; the yield curve is still very flat

In 2/10 space, the extreme over the past 3-4 months comes in slightly higher than today’s levels. It strikes us, that despite the Fed pausing, if this curve were going to make a broader move steeper, now is the time. It’s a counter trade to the extreme moves and themes of 2019, and the variables appear to be aligned. 

Similar to 2016, we are not suggesting a 200-basis point move in the 2/10 curve, but a break in global rates (the US included) of the key technical levels, in conjunction with short end rates remaining anchored could lend to more price action of the past few days. Lower prices, steeper curve. 

The US 2/10 Curve and Outright Market at Key Levels

Source: Bloomberg

The Fed

This was an active week from the New York Fed. And the continued reversal of the Fed’s approach to the hiccups since mid-September.

We’ve been discussing the notion that the Fed will not run away from the issues of the past few months. There is simply too much at stake between Repo, Federal deficits and the Libor to SOFR conversion with clear end user implications. 

Money Market Developments: Views from the Desk

November 04, 2019

Lorie K. Logan, Senior Vice President

From this week: NY Fed: “That said, the Desk is prepared to adjust the pace and other parameters of the reserve management purchases as necessary to maintain an ample supply of reserves and based on money market conditions. We’ll be closely monitoring the attractiveness of propositions and indicators of market functioning to assess whether operational adjustments are appropriate”

The bazooka is out, and it’s focused on the short end. One of the reasons clearly, we focus on the yield curve here. The Fed wants the curve steeper irregardless. But with regards to the asset purchases, we’ve been discussing how short-term it’s all about the bank reserve levels.

Granted, the banks seem likely to get some relief on the daylight overdraft. And Jamie Dimon referred to this specifically recently. But the broader capital and liquidity ratios become a different animal, especially heading into a very contentious political season. Senator Warren was quick to point out and we’ve discussed. 

So, for us, what this means is more buffer not less regarding the reserve levels. And when reading Lorie Logan’s speech, and certainly the comments from Powell and Williams, the message of more not less is clear. 

Furthermore, the NY Fed is tying in SOFR with this recent discussion. And they need to. The practical and political implications of the mid-September Repo hiccup transcend just funding.

The regulators have mandated Libor conversion to SOFR. And in a nutshell, SOFR is Repo. No running away from the broader implications for the financial system and economy. The Libor market has touched every corner of the domestic and global economy. 

Both pieces attached below and worth a read. Regarding SOFR, the release is around calculation methodology and clearly timed out with the recent bumps in Repo rates and implications for SOFR calculations. 

https://www.newyorkfed.org/newsevents/speeches/2019/log191104

https://www.newyorkfed.org/markets/opolicy/operating_policy_191104

In looking back at this past year, and listening to the Fed speak since the October 30th announcement, the thing that stands out the most right now is the conviction the Fed presents with and in both directions.

We spent some time compiling some Fed speak going back to the Fall of 2018, making comparisons to what we are hearing today.

Let’s Take a look:

Clarida today 2019 after 3 rate cuts: It’s ALL in a “good place”

1) Economy

2) Fed policy

3) Jobs report

Clarida from October 25, 2018: And on his way to 3% neutral:

 “Even after our most recent policy decision to RAISE the range for the federal funds rate by 1/4 percentage point, monetary policy remains ACCOMMODATIVE, and I believe some further gradual adjustment in the policy rate range will likely be appropriate” 

Dallas Fed’s Kaplan 2019.

“Fed policy is in the right place”

Kaplan from August of 2018:

Worried about raising rates too gradually as to not fall behind the curve. “At this juncture, the challenge for the Fed is to raise the federal funds rate in a gradual manner calibrated to extend this expansion, but not so gradually as to get behind the curve so that we have to play catch-up and raise rates quickly”

NY Fed President Williams 2019 (November 2019)

Fed is close to neutral. Policy and economy in a good place. 

https://www.wsj.com/articles/feds-williams-says-no-rate-changes-penciled-in-now-economy-will-drive-policy-11573058005

Williams 2018 (December 2018)

Fed’s Williams says rate hikes ‘over next year or so’ still make sense.

https://www.cnbc.com/2018/12/04/feds-williams-expects-further-us-rate-increases-into-next-year.html

It’s too early to tell if the Fed has it right this time around. Last year they were very off course. This story is far from over, and for now the markets trade with optimism and a belief the Fed has the economy and policy in a good place.