Thursday will go down as one of the more memorable sessions in a year full of them on Wall Street.
The cross-asset jamboree set in motion by a cooler-than-expected October CPI report in the US put a simple stock-bond portfolio on track for a truly stupendous one-day rally (figure below).
Through noon, US equities were 5% higher (6% for tech) and US yields 30bps (or more) lower through the 10-year sector. 2022 has been unimaginably cruel to both stocks and bonds. Multi-asset portfolios were due for a reprieve.
Thursday’s gains could evaporate in the days ahead. Nevertheless, the reaction to October’s inflation figures won’t soon be forgotten.
The repricing in rates was dramatic. Swaps showed just 52bps priced for the December FOMC meeting — a fifth consecutive three-quarter point hike from the Fed was priced almost entirely out of consideration. Perhaps more interestingly, just one additional 50bps hike was priced by mid-2023.
Terminal rate pricing receded all the way back below 4.90%, consistent will levels hit after Nick Timiraos and Mary Daly first telegraphed the Fed’s intention to consider a step-down in the pace of hikes (figure below).
On Wednesday afternoon, the market priced peak Fed funds at 5.05%. 24 hours later, the market’s best guess was 4.88%.
The Fed is keen to suggest that whatever the pace, rates are very likely to reach 5% (at least) and stay there for a prolonged period. Barring additional (and more convincing) evidence of cooler inflation, that notion will likely be enshrined in the December dot plot.
The market, though, is keen to fade the idea of an obdurate Fed at the first opportunity. On Thursday, in Treasury options, a bullish structure targeted a drop in five-year yields to 3% between now and late February. In the exciting world of SOFR options, traders targeted just one more 50bps move for the cycle.
