KC and the Sunshine Band
December 28, 2021
–Light volume in rate futures; the curve flattened, weighed by the two year auction yesterday with fives on the slate for today. The two year yield rose 2 bps while the 30y bond fell 2 bps. SPX rumbled to a new all-time high, though Nasdaq is still below the high from late November (16212). On the other hand, Nasdaq has surged 6% in the last four sessions. Also putting in a sizzling performance is the March Soybean contract, up over 9% in the last eight sessions to this morning’s 1381. The high settle this year of S H2 is 1433 in June. Big jump yesterday in WTI, with CLG2 +2.12 late to 75.91.
–New high settle in March/June 3-month ED spread at 24.5, up 0.5 (EDH’22/EDM’22). That spread is reflecting at least one hike with certainty. However, it could still be considered cheap depending on the aggressiveness of the hiking cycle. The March FOMC is 16-March but EDH2 expires the Monday before on 14-March. I personally think the first hike will be May 4; the next meeting is six weeks later on 15-June. Again, EDM2 expires the Monday prior, on 13-June. My scenario on a timetable is that the Fed will at most hike only four times in the first year, so I doubt there will be increases on consecutive meetings. In connection with thoughts on a rate hike schedule, the Kansas City Fed put out an interesting paper on the composition of stimulus withdrawal, noting that the Fed’s FF hikes contributed to flattening and even inversion of the curve after the GFC. “A flat or inverted yield curve may signal pessimism about the economic outlook. More importantly however, it can also materially affect firms that profit from the spread between short- and long-term interest rates, such as banks and investment funds.” [and we CAN’T have lowered profits in the financial industry, now can we]. The note concludes:
Overall, evidence from the normalization of monetary policy after the Great Recession highlights that the order in which policymakers normalize monetary policy matters. The sequence of normalization from 2015 through 2019 appears to have contributed to flattening in the yield curve, which can generate financial conditions that make future downturns more likely. Reducing the balance sheet before raising interest rates might forestall yield curve inversion in future normalizations. [Somewhat amusing the word “normalization” can be used 4 times in such a short paragraph in an episode that resulted in anything but a ‘normal’ outcome].
The point, which I agree with, is that a flatter curve might not be particularly helpful with respect to the Fed’s policy goals. It’s worth keeping in mind that Mester, who runs the KC Fed. is a voter next year.
https://www.kansascityfed.org/research/economic-bulletin/when-normalizing-monetary-policy-the-order-of-operations-matters/
you’re welcome
