Possible inflection point in the US curve?
December 26. 2022
–Yields rose Friday with tens up 7 bps to 3.743%. This week brings auctions of 2s, 5s and 7s starting today (Tuesday).
–Large new buyer Friday of SFRM3/U3 calendar at -19. Volume was >50k, open interest up about 11k in both contracts. SFRH3/M3 is -0.5 (9512/9512.5) so if the Fed is able to convince the market that rates will stay high through 2023, then M3/U3 should roll up towards H3/M3. However, the curve has a bias toward easing which has been in place for quite some time. The most inverted three-month calendar is Dec’23/March’24 at -39 (9561/9600). While many observers look for a terminal FF rate at 5% or higher, the SFRH4 contract settled at just 4% (9600).
–Over the weekend Klaas Knot told the FT, “…with five policy meetings between now and July 2023, the ECB would achieve ‘quite a decent pace of tightening’ through half percentage point rises in the months ahead before borrowing costs eventually peaked by the summer.” So that’s the ECB playbook and the US curve is projecting the same, with the peak rate projected by the US Fed Fund curve being May and June’23 contracts at 9509.5 or 4.905%. The first four FOMC announcement dates are Feb 1, March 22, May 3 and June 14. Current EFFR is 433. If the Fed hikes 25 at the next three meetings, then EFFR will be 508, about 18 higher than what is being projected by FFM3. BoJ sent a shock through markets last week by raising the cap on the 10y JGB to 50 bps, and Kuroda’s term ends in April, which is expected to mark the end of ultra-loose policy.
–Will more aggressive policies from other central banks lessen the pressure on the Fed to hike more, or will it lead to a weaker dollar which exacerbates inflation dynamics. I lean toward the former, and expect the structural short in the US curve will start to be unwound, which, along with capital being repatriated to Japan, will lead to higher US rates at the LONG end.
