“Numb.”
That’s how Nomura’s Charlie McElligott described market participants’ disposition vis-à-vis never-ending Fed banter centered on the necessity (or at least the desirability) of getting to neutral “expeditiously.”
US equities were buoyant Tuesday despite the latest escalation from Jim Bullard, who’s one (more) CPI overshoot away from raising the specter of 100bps increments. I’m just kidding. I think.
Evans weighed in with his own “beyond neutral” comments, but said he doesn’t see any need for hikes larger than 50bps. The media headlines give you a sense of the zeitgeist. “Last-Resort Fed Hike Enters Debate as Bullard Invokes 1994 Move,” Bloomberg mused.
Rates are still trying to price these incremental shots across the bow. Treasurys bear flattened Tuesday in fairly aggressive fashion, with 2s cheaper by 15bps (figure below).
Remember: This is coming off ~40bps of steepening after the fleeting inversion. Tuesday was only the second bear flattening session since April 1. It’s a crapshoot, and so are equities.
“We’ve seen a broad return to day-trading in the Vol space, as evidenced by the ever-growing popularity of short-dated options, which is making for the return of silly intraday overshoots on dealer hedging flows,” McElligott remarked, in his first note back from a short break. That said, the ebb and flow of sector and thematic pivots is suppressing close-to-close vol via the dispersion effect. We’ve seen that before.
Coming quickly back to the Fed, Charlie (McElligott, not Evans) said many clients “have grown outright numb and skeptical of further hawkish catalysts.” As discussed here, there’s nowhere else to go for Fed pricing on the hawkish side, absent some extremely unfavorable turn on the inflation front. Fed funds futures are “consistent with inflation vigilantism of the 70s and 80s and in clear discord with this century’s gradualism,” Deutsche Bank’s Aleksandar Kocic wrote last week.
Hence the view that the Fed is fully priced, “at least locally” and at least “for now,” as McElligott wrote Tuesday, citing the March CPI report which, while very rough, at least printed below consensus on the MoM core reading, providing “a glimmer of hope” to the “peak inflation” crowd.
Of course, another overshoot is by no means an impossibility. Last week’s cooler-than-expected core CPI print was at least partially offset (from a psychological perspective) by a disconcerting PPI report the following day.
In any case, STIRs (and stocks) have moved on. “The Fed getting to neutral is a yawn now,” McElligott went on to say. For that to change, “you’re gonna need to hear widespread FOMC advocacy of running restrictive policy, requiring upgraded rhetoric from the Fed stating that they’d be willing to negatively impact the labor market in order to crush the inflation,” he added.
As for market pricing, you’d need to see a shift in the implied peak (currently mid-2023) and a subsequent adding back of additional hikes late next year and into 2024. Currently, that period is priced for rate cuts.
“The market has transitioned its focus from Fed tightening into the future cycle implications of said policy,” McElligott said. For now, the theme is “pre-trading the recession.”
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