USD Swaps: Bull-steepener grinds on; Finishing touches on FOMC views

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Bull-steepener grinds on; Finishing touches on FOMC views

Treasuries have built on their emphatic knee-jerk reaction to yesterday’s below-forecast CPI with some more bull steepening heading into the final FOMC decision of 2022.  The benchmark 10y note yield is another 1.5bps lower at 3.486% while the 2s10s spread is another 3.1bps wider at -69.2bps.  Meanwhile, red and green Eurodollars are 1 to 10 ticks firmer today while Fed funds futures now see the terminal rate at 4.82% (implied) for the May23 contract.  In risk assets, the major domestic equity indices are modestly in the green (Dow +0.62%, S&P +0.57%, Nasdaq +0.67%) while the energy complex is also posting gains (gasoline +2.25%, Brent +2.26%, WTI +2.52%) Finally, swap spreads are retracing modestly lower after yesterday's widening in the front end and belly and are tighter across the board. Meanwhile IG issuance is completely offline and is likely done for the year.  

Looking ahead, while Fed officials were in not doubt celebrating yesterday’s softer-than-expected CPI data, one source cautioned that “we can be certain of sober pragmatism in their steadfast stance regarding inflation.”  That said, he judged that there was also the prospect of the Fed “negotiating” with the market by acknowledging its progress on the inflation front.

For their part, following yesterday’s print, much of strategists at Barclays CPI forecast “continues to hold,” though they see “growing downside risks to the rate path.”  While the bank thinks that “a 50bp hike at the December FOMC meeting…is all but a done deal,” it believes that “we could potentially see downward revisions to the policy rate path implied by the SEP dot plot.” In essence, while Barclays holds its baseline forecast “unchanged for an additional 50bp hike in February 2023, followed by a 25bp rise in March 2023,” it sees “additional downside risks to that rate path in the aftermath of the November CPI release.” 

And on net, Barclays continues to see two-sided risks to its CPI forecast, especially further into 2023:

”… If our projections are correct, consumer price inflation should be slowing while wage inflation may remain robust amid tight labor markets. This mechanically and intuitively leads to rising real wages, which naturally would lead to increased consumer demand, and represents a potential upside risk to the path of inflation throughout 2023. On the flip side, were the US economy to enter a recession, as we predict next year, it is possible that the drop in aggregate demand could be more deflationary than assumed. On net, we remain in a period of elevated macroeconomic risk and uncertainty, even if peak inflationary pressures may have already occurred, and, in our opinion, the November CPI print did little to change this longer-running narrative.”

Meanwhile, a step down from 75bp to 50bp that would nudge the fed funds target range up to 4.25-4.50% “is overwhelmingly discounted,” in the view of strategists at SocGen.  Thus, the bank believes that “the swing factor today will be the updated macro forecasts and press conference”.   On that, SocGen shares its views below:

”…With core inflation slowing for a second month to 6.0% yoy (4.3% annualised over the past three months), the debate is logically gaining traction as to  whether the Fed could pause after one more 50bp (two 25bp?), or one 25bp, in 1Q23. The FOMC statement and Powell will as usual steer clear of committing to the next meeting, but nuances  will as ever be crucial. Does Powell for example still think the bank has “some ways to go”? The OIS forwards are now pricing a peak around 4.85% in May 2023, having shaved off 15bp yesterday after the CPI. The message is: no further tightening beyond 5%. Hence the slump in 2y yields to a low of 4.13% and the sell-off in the DXY below 104. For the new dot plot, the SG economics team has pencilled in an upgrade to 5.0-5.25% for the end of 2023 from 4.50-4.75% in September. The likelihood of 5.25-5.50% has come down after yesterday. With the labour market still running hot and annual wage growth of 5.1% inconsistent with a return of inflation to target, Fed chair Powell faces the unpopular choice of stealing the market’s Christmas.” 

Currently, SOFR swaps – 2s 1.5bps (-1.5bps), 3s -13.25bps (-0.375bps), 5s -22.625bps (-0.375bps), 7s -31.875bps (-0.25bps), 10s -30bps (-0.125bps), 20s -61.5bps (-0.5bps), 30s -66.25bps (-1bps).