FOMC Day
December 14, 2022
–CPI lower than expected, up just 0.1 month/month with yoy 7.1% vs 7.3 expected and Core 6.0 vs 6.1 expected. A Timiraos (WSJ) bullet point followed: “THE FED IS ON TRACK TO RAISE INTEREST RATES BY 50 BASIS POINTS TOMORROW, BUT LOWER INFLATION COULD COMPLICATE THE 5% TARGET – WSJ” Bloomberg this morning has a headline, “Fed to downshift…but point to higher peak”
Short-term rate futures have signaled a peak rate of around 5% for quite some time, followed by easing. For example, SFRM3 yesterday settled 9518 or 4.82%, while six months forward SFRZ3 settled 9571.5 or 4.285%, more than 50 bps lower in yield; the same magnitude as today’s hike. The new Fed Effective today should be 433 bps, and indeed FFF3 settled 9566.5 or 433.5. FFG3 settled 9535 (a spread of 32 to 433), leaning heavily toward a hike of just 25 bps at the Feb 1 FOMC.
–Implied vol was crushed with the benign CPI release. For example, SFRH3 9512.5^ settled 33.0 Monday vs 9505.5. Yesterday, the underlying contract soared 11.5 to 9517, but the straddle settled 27.0. The challenge for Powell is to convey that the downshift could easily mean a pause, but NOT an ease. Of course, as noted above, the easing is being priced already.
–Late ESH3 was 4055 late, fully 125 off the euphoric high of 4180 post-CPI. Treasury yields ended lower, especially in the front. Twos fell 17.6 bps to 4.225% while the 30y bond was down only 5 bps to 3.525% as yesterday’s auction resulted in a tail of over 3 bps with bid/cover only 2.25 vs an average of 2.39. After today, the entire treasury curve will have negative carry with a funding rate of around 4.3%. If Powell can gently guide towards pause, then structural curve shorts may begin to unwind, which would pressure the long end and partially negate the easing of financial conditions seen elsewhere.
