FF > CPI by Q2?

September 18, 2022 – Weekly Comment

The event of the week is, of course, the FOMC result and press conference on Wednesday.  Though there are a few outliers looking for a rate increase of 100 bps, FFV2 ended the week at 9688 or 312 bps, close to what will be the new EFFR of 308 on a 75 bp hike.  What is perhaps of more interest is November Fed Funds which settled 9625, or 375 bps.  This level roughly prices even odds of an additional 50 or 75 at the November 2 FOMC.  Powell takes what the market allows.

The peak Fed Funds rate in 2006 at the end of that cycle was 5.25%.  In that episode the Fed hiked  25 bps at every meeting, starting June 2004.  What’s somewhat interesting is that the 30y yield peaked JUST PRIOR to the start of the cycle at 5.46% and at the very end, in mid-2006, was 5.25%. [Greenspan’s conundrum]. In looking at the 2015 to 2018 hike period, just before the onset, thirties peaked at 3.24% (mid-2015) and had a hard time getting though that level until the very end of the cycle, peaking only 20 bps higher at 3.45% in Nov 2018, (against the peak FF rate 2.25/2.50%).

But that’s not the same case now.  On Friday the thirty-year yield ended 3.51%, the highest since 2014.  By the end of the 2004/06 hike cycle FF and 30yr were essentially equal.  In the cycle ending 2018, the FF rate never approached the 30y yield until well after the Fed’s campaign stopped and long end yields were rapidly declining.   

The difference now of course, is pernicious inflation.  Let’s assume for a second that the Fed hikes 75 both next week and in November.  EFFR will be 383, quite a bit higher than the current 30 yr yield of 3.51%. Even if the Nov hike is 50, EFFR will be 358. 

Note that the lowest contract on the FF strip is April 2023 at a price of 9560.5 or 4.395%.  The lowest ED and SOFR contracts are March’23 at 9541.5 (4.585%) and 9565.5 (4.345%).  In my opinion, given the absence of Fed buying, 30yr yields should be adjusting higher. Certainly that IS the case with 30-yr mortgage rates, which this week set a new high of 6.02% according to the FRED data series, and 6.28% according to Bankrate.

Given that US curves forecast an end to rate hikes by Q2, it would be helpful to model CPI under various assumptions.  There’s a helpful table on Mauldin’s  ‘Thoughts from the Frontline’ citing Bespoke Investment Research of London.  Given CPI prints that have already occurred through July, the table shows forward levels given 0.0% increases per month, 0.1%, 0.2%, 0.3% etc,  If the monthly rate going forward were zero, by April 2023, CPI will be 2.48%.  At 0.1%, 3.41%, at 0.2%, 4.34%, at 0.3%, 5.28% and at 0.4%, 6.4%.  Note that FFJ2 is 4.395%, so if that contract were to be correct in its forecast of Fed hikes, then the rate it implies would be just higher than inflation (at that time) at increases in CPI of 0.2% per month.  Both would likely be higher than the 30y yield. Note that in last week’s CPI release for August, CPI MoM was 0.1% and Core was 0.6%.  PPI was -0.1% with Core +0.4%.

I can’t copy the Bespoke table, but here’s a link.  Article title is ‘Inflation Sinks In’

If inflation really does begin to moderate, it may be a much different picture by Q2 of next year.  However, without the Fed buying, long yields should continue to adjust higher.  Carry will be squeezed out and the decline in global trade perhaps means that fewer US dollars are recycled into treasuries.

Currently the highest point on the treasury curve is the 20-year at 3.78%.  There is a 20y auction this week on Tuesday.  The last round of auctions met with tepid demand.  I don’t expect this one to be much better.

Going into the end of 2013’s ‘taper tantrum’ the 30-year yield peaked at 3.97%, about 50 bps higher than the current yield, though the Fed never even actually raised the FF target.  In USZ 4% roughly corresponds to about 7.25 points lower in price, around 123-24 to 124-00. 


NY Fed’s Global Supply Chain Index has declined for the past four months

Atlanta Fed GDP Now was about 1.3% for the first half of September, but on Sept 15 was marked down to 0.5%.  Perhaps more worrisome, the Blue Chip Average forecast was marked down from 1.1% to negative 0.2%.  More ominous than that, interest rates aren’t providing an offset to weakness in stocks and wealth destruction.  Quite the opposite. 

Selected changes in big caps and averages:

Percent Changes

                Week    ytd         level      pre-covid high

AAPL      -4.2        -15.4      150.70   81.80

GOOGL -7.0        -29.7      102.80   76.23

MSFT     -7.5        -27.9      244.74   188.70

META    -13.5      -56.5      146.29   223.83

NVDA    -8.2        -55.4      131.98   78.67

AMZN   -7.3        -25.9      123.53   108.51

SPX        -4.8        -18.7      3873       3386

COMP   -5.5        -26.8      11448    9317


UST 2Y356.7385.428.7
UST 5Y344.2362.418.2
UST 10Y331.9344.712.8
UST 30Y345.5351.66.1
GERM 2Y132.7153.320.6
GERM 10Y169.7175.65.9
JPN 30Y131.0128.7-2.3
CHINA 10Y264.2268.03.8
SOFR Z2/Z3-32.5-31.51.0
SOFR Z3/Z4-49.5-65.0-15.5
SOFR Z4/Z5-10.5-18.0-7.5
CRUDE (CLZ2)85.7584.07-1.68
Posted on September 18, 2022 at 11:29 am by alexmanzara · Permalink
In: Eurodollar Options

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