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USTs consolidate a tad; Dealers eye wider spreads
Market participants were decidedly rattled at the prospect of even more tightening as a data-dependent Fed received numerous indications in the data this week that its “higher for longer” mantra may actually be the wisest path ahead. Indeed, one source reckoned after this week's data dump that “the economy seems as strong and resilient as inflation and there are more and more people in soft-landing or no landing island right now."
And while hawkish comments from some Fed officials this week (i.e. Mester & Bullard) re-opened the door for 50bps hikes, Richmond Fed President Barkin pushed back on the very notion today. “I like the 25 basis-point path,” Barkin quipped. It “gives us the flexibility to respond” to the incoming data. Still, other officials were quick to re-enforce the notion that the Fed won’t be done hiking – regardless of the pace – until inflation is dead. Indeed, Governor Bowman said today that “we’ll have to continue to raise the federal funds rate until we start to see a lot more progress” on taming inflation.
Against this backdrop, Treasury yields are nudging lower after an unmistakably bearish run this past week. The benchmark 10y yield is last 3.1bps lower at 3.83% while the 5s30s spread is 0.6bps wider at -16.6bps. However, with the Fed’s broader message still ringing load and clear in many minds after this week, one source reckoned that today’s modest reversal in USTs was “just an oversold bounce into the long weekend.”
Meanwhile, in swaps, spreads are narrowly mixed amid above-average activity, best seen a the 5y and 10y points. In the backdrop, IG issuance is offline ahead on the long holiday weekend after an outsized $54bn priced – almost double initial estimates – in the wake of Amgen’s massive $24bn mega-deal yesterday.
Separately, in the dealer research, analysts at Barclays maintain their recommendation to be long 10y SOFR spreads. “From a levels perspective, further tightening in 10y spreads would put them in the context of March 2020, when dealer balance sheets were bloated and Treasury market functionality was disrupted” and “while conditions have worsened over the past year, they are still benign compared to 2020,” the bank highlights.
Analysts at JP Morgan are also positioned for wider swap spreads, “as a stabilization in the dollar should help sustain better foreign official demand for USTs, and bond fund AUMs are trending higher.”
To be sure, JP Morgan points out that “the aggregate AUM of the largest bond funds has been steadily climbing since reaching its lows in late 2022” and it believes that overall that “a steady rising trend appears to be in place.” Consequently, “such a continued rise would represent a source of widening pressure for long end swap spreads in particular - as a rule of thumb, a 10% rise in bond fund AUM would likely pressure 30y swap spreads wider by 1.2bp.”
Currently, SOFR swaps – 2s 5.875bps(-1.25bps), 3s -6.625bps (+0.875bps), 5s -20.875bps (-0.125bps), 7s -30bps (-0.125bps), 10s -28.375bps (-0.125bps), 20s -59.75bps (-0.75bps), -69.375bps (-1.25bps).
Deutsche Bank: No landing is not an option for the Fed
Earlier this week strategists at Deutsche Bank lifted their expectations for the terminal fed funds rate to 5.6%. The bank explains that “this re-think was motivated by recent data and revisions that showed significantly more resilience in the labor market, a pickup in growth momentum, and persistent inflation pressures. With financial conditions recently loosening, it became clear the Fed would have to act more aggressively to achieve a ‘sufficiently restrictive’ monetary stance.” Against this backdrop, Deutsche Bank presents the following views/forecasts:
- ”… . The latest developments support our baseline expectation for a moderate recession rather than a soft landing. That said, firmer near-term strength in the economy and lack of FCI tightening suggests that the timing of a recession is likely to be delayed. We now expect the first quarter of the recession in Q4 of this year (versus Q3 previously) with the Fed's first rate cut coming in Q1 2024 (versus Q4 2023 previously). We maintain our views that the unemployment rate is likely to peak in the 5-5.5% range and that the nominal neutral rate is around 3%.
“…While we anticipate that the Fed will continue in 25bp increments, and that the bar for returning to a 50bp pace is high, it is not insurmountable. Indeed, if financial conditions remain stubbornly loose and the Fed were to conclude that ‘sufficiently restrictive’ was at least as high as our current baseline call of 5.6%, the case for returning briefly to a larger increment would be compelling. “