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Putin assists bond rally; If FCI is easing, policy isn't tight
The bond bulls have completely wrestled command of the Treasury market with headlines that Russian President Putin sees the risk of nuclear war in the world rising, adding a collective dose of angst that has helped fueled the bid today.
To be sure, the benchmark 10y note is last 7.7bps lower at 3.455% after a quick test of 3.40% once the headline hit the tape earlier. On the curve, the 2s10s spread is 1bps wider at -83.2bps while the 5s30s spread is 0.5bps wider at -20.6bps.
In the Eurodollar trading pits, reds and greens are 3.5 to 10 ticks firmer as that sector of the strip bull steepens today. Meanwhile, swap spreads are wider across the board with IG issuance slow to build in the backdrop despite a relatively tame trade in the major domestic equity indices thus far today (Dow +0.41%, S&P -0.03%, Nasdaq +0.01%).
More broadly, financial markets want the Fed pivot, badly. Indeed, Fed speak has recently been interpreted as less hawkish and the market has run with it as (1) rates have declined, and (2) financial conditions eased. However, strategists at BofA caution that “there is only one problem- wages and inflation are still too high. The Fed can't be done” and that “the Fed would likely find it difficult to lower inflation if financial asset prices are rising.”
BofA notes that “a slower pace of hikes without a credible commitment to remain higher for longer has eased financial conditions. The market does not appear to be fully convinced by the Fed's higher for longer talk. The Fed would either need to strengthen credibility of higher for longer or keep raising terminal.”
Turning to the market implications of a Fed that doesn't make higher for longer credible, BofA highlights “(1) premature pivot = lower reals and easier FCI (Financial Conditions Index); (2) higher terminal = flatter curve” and expounds on both below:
- ”… Premature pivot = lower reals: If the Fed aims for a lower terminal with non-credible higher for longer commitment the market could see it as a premature pivot. The market would likely hold early and large rate cuts + easing FCI. Fed premature pivot dynamics would keep lowering long-dated real rates because of: (1) pricing of rate cut, (2) higher LR inflation risk…The rates market has been surprisingly willing to lower both nominal and real rates. There has been only modest widening in longer-dated TIPS breakevens. Limited moves in long-dated breakevens imply that a premature Fed pivot and easing FCI will not see inflation rise much. We are skeptical and expect LR breakevens to widen + reals lower if Fed pivot holds. Long real rates has been one of our core '23 recommendations.
“…Higher terminal = flatter curve: A premature Fed pivot without credible higher for longer commitment would likely see a higher terminal rate. If higher for longer can't be made credible the Fed would keep hiking until the economy responds. This raises risks to 6%+ terminal levels & an even flatter UST curve…The UST curve would likely keep flattening until Fed hikes are near done or until inflation/ employment crack. We see risks to higher terminal with strong inflation/ labor.
“…Bottom line: FCI easing means policy isn't tight. Fed would struggle to lower inflation if asset prices keep rising. FCI easing is driven less by terminal & more by rate cuts. Fed higher for longer is not credible & slowing in hike pace is seen as easing. Fed is unlikely to strengthen the higher for longer commitment, which means (1) premature pivot concerns to build, lowering real rates; (2) higher Fed terminal seems likely, flattening curve…Powell may need to push back on FCI easing, watch for Dec FOMC hawkish dose.”
Currently, SOFR swaps – 2s 4bps (+0.875bps), 3s -16.875bps (+0.5bps), 5s -25.125bps (+0.625bps), 7s -34.5bps (+0.75bps), 10s -32bps (+0.375bps), 20s -64.875bps (+1.75bps), 30s -67.625bps (+1.125bps).
Formosas & ZC callables
- Nordic Investment Bank sold a $50m 20y NC6 zero-coupon callable. The EMTN matures Dec 2042 and has a single call on Dec 2028. Lead RBC London. Estimated IRR 4.745%. Announced Dec 7.
- ICBC Macau Branch is working on a 2y Reg S 2y FRN benchmark. A/A1/A. Price talk: SOFR + 80bps area.
- National Rural Utilities is working on a $350m 5y deal JPM, MIZ, MUFG, RBC and TSI. A2A-/A. Price talk: +135bps area.