USD Swaps: Oscillating around 4%; What will it take for a 50bps hike?

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Oscillating around 4%; What will it take for a 50bps hike?

This morning’s ISM Services data caused a minor hiccup in today’s price action as the headline came in a smidgen stronger-than-expected (55.1 versus 54.5 Bloomberg consensus), the employment sub-component ticked up to 54 (from a prior 50), and the new orders sub-component rose to 62.6 (versus 60.4 prior).  However, the prices paid sub-component ticked down to 65.6 (versus 67.8 prior) which was somewhat soothing in the wake of some recent troubling pricing data.  Digging a little deeper into the data, strategists at Barclays highlight the following:

”… The ISM services composite was little changed in February at 55.1, with mixed readings across categories. February's reading exceeded expectations (Barclays 54.4, consensus 50.5), strongly suggesting that the dip in the PMI to contractionary territory in December was a one-off. February's reading reflected mixed readings across categories, with declines in the indices for business activity (-4.1pts, to 56.3) and supplier delivery delays (-2.4pts, to 47.6) roughly offsetting higher readings for employment (+4.0pts, to 54.0) and new orders (+2.2pts, to 62.6). Growth was broad-based, with 13 of the 18 non-manufacturing industries in the survey reporting gains last month, up from 12 in January

 

”… The ISM services PMI remained strong in February, after having slipped below 50 at the end of 2022, amid signs of improving domestic and external demand. In our view, today's strong reading seriously undermines some prevailing narratives that warm weather and inappropriate seasonals explain January's re-acceleration.”

Heading into the print, Treasuries were on a nascent bull-flattening run with the benchmark 10y note yield settled slightly below the much-ballyhooed 4% mark.  However, the data caused a quick knee jerk sell-off that took the 10y note back above 4% for a bit before buyers – or increasingly short coverers, according to sources – came in to reverse the market’s course with a little added impetus the Fed’s monetary policy report today that said “high inflation is not becoming entrenched" (see full report here).  Indeed, one source quipped that he’d “anticipate some chips to be taken off the table in this neighborhood” when the 10y note was trading north of 4% yesterday.

And currently, in the early afternoon trade, the benchmark 10y note yield has settled 8.6bps lower at 3.969% while the 5s30s spread had compressed 3.6bps to -35.7bps.  Shorter in, red and green SOFR futures are anywhere from 3 to 10 ticks firmer as some of this week’s weakness consolidates into the weekend. 

Meanwhile, swap spreads mixed with the spread curve steepening against the bull-flattening in underlying rates.  In the backdrop, IG issuance has dried up this session despite a firm risk backdrop (Dow +0.86%, S&P +1.30%, Nasdaq +1.64%) after over $43bn in deals already priced for the week.  And looking forward, syndicate desk s have penciled in roughly $35bn in new deals for the upcoming week. 

More broadly, confidence in how quickly inflation can fall towards the Fed's target was challenged this week by the prices paid component on ISM manufacturing and the outsized jump in unit labor cost.  And amidst this week’s troubling inflation data, numerous Fed officials swooped in to hold the Fed’s line on ‘higher for longer’. 

Notably, Minneapolis Fed President Kashkari said on Wednesday that he’s “open-minded, at this point, about whether it’s 25 or 50 basis points” for the Fed's next rate hike at the upcoming March FOMC meeting (with a 25% probability of a 50bp hike priced in).  So, the million-dollar question remains ‘What will it take for the Fed to deliver a 50bps hike?’  Well, strategists at BofA share their view on this puzzling question below:

”…We continue to think that the bar for a 50bps rate hike is high for the Fed. Going back on Powell's guidance at the January FOMC would challenge the Fed's credibility, but we don't rule it out entirely. We think two things likely need to happen for the Fed to take this step: 1) inflation expectations show signs of un-anchoring, and 2) the data shows signs that the US economy is re-accelerating.

 

“…Inflation compensation particularly at the front-end of the curve has increased over the past few weeks, though is still well below levels observed in the middle of last year. We think that signs of unanchored inflation expectations were a major factor last summer driving the Fed to go back on their prior guidance of 50bps and instead deliver 75bps.

 

“…Our US Economics team does not think that the data is accelerating, but it certainly has been stronger than anticipated coming into the year. Following the January FOMC when Powell failed to push back on the easing in financial conditions and endorsed a data dependent stance, we recommended clients receive March FOMC OIS on an attractive risk/potential reward. The trade hit its stop out this week as data continues to endorse a need for the Fed to do more vs less.”

Currently, SOFR swaps – 2s 9.375bps (-0.75bps), 3s -7.25bps (-1.375bps), 5s -18.625bps (-0.25bps), 7s -29.5bps (+0.625bps), 10s -26.125bps (+0.25bps), 20s -61.375bps (+0.75bps), 30s -66.625bps (+0.375bps).