Gratifying disinflationary process; USTs, swaps rally
Treasuries rallied double digits during the Q&A after the FOMC hiked 25bps as was widely expected. Powell spoke the d-word - disinflation - in noting that the “disinflationary process has started” and it was “gratifying” to see. As far as financial conditions, Powell saw that they have “certainly tightened” but that “there’s still work to do there,” and that it would be “very premature to declare victory” on price pressures. Later Powell stated that ongoing rate hikes means “a couple” more.
Treasury yields are last 7.5 to 13.5bps lower on the day, with the belly leading the move. The 10y note yield is last 3.406% or 10.5bps lower. 2s10s is 0.6bps flatter at -69bps while 5s30s is 5.8bps steeper at 7.5bps. Equities closed higher (DJIA +0.02%, S&P +1.13% and Nasdaq +2%).
Going into the FOMC, one senior hedge fund manager believed that the market “might try to rally or wants to rally” after the FOMC, but he regarded that the rally would “hit a wall… because the February data will be better than most anticipate, starting with core CPI" on the 14th. Indeed, Powell highlighted that core services ex-shelter needs to show disinflation before the Fed can declare victory.
Swap spreads widened out with the underlying rally in Treasuries amid mostly lower than average volumes outside the 3y and 30y. IG new issuance was offline for the second session in a row, with only $7.7bn thus far for the week – and the IG market has some catching up to do to make the $20-25bn estimated for the week.
Currently, SOFR swaps 2s +3bps (+0.75bps), 3s -10.25bps (+2.125bps), 5s -20.5bps (+1.125bps), 7s -28.5bps (+2bps), 10s -28.75bps (+1.5bps), 20s -57.25bps (+3bps), 30s -65.25bps (+2.5bps).
Stable dollar portends less widening in long end spreads – JP Morgan
Analysts at JP Morgan find the YTD widening in long end spreads “noteworthy,” with, for instance, 20y and 30y swap spreads widening “by 11bp since the end of last year.” However, the bank believes that “much of this reflects moves in the underlying drivers themselves, as opposed to a reversion to fair value.”
In particular, “the sharp weakening in the dollar in January has been the predominant driver behind the widening in long end spreads, as suggested by our fair value for 30-year SOFR maturity matched swap spreads,” JP Morgan highlights.
“But with the dollar now stabilizing since mid-January, long end spread widening may have run its course in the near term,” it assesses and therefore the bank favors a neutral stance for 30y swap spreads.
On the other hand, JP Morgan finds that 20y spreads “continue to appear wide” in relation to the level of 10y and 30y swap spreads “and offer an attractive spot for spread narrowing exposure.” Examining the 20s/30s maturity matched swap spread curve, adjusted for the level of 30-year swap spreads and the 20s/30s Treasury curve, it finds that “this spread curve now appears too flat adjusted for these drivers and should be biased asymmetrically steeper if the 20s/30s Treasury curve flattens as we expect.” Therefore, JP Morgan now recommends “a 100:70 weighted 20s/30s swap spread curve steepener.”