The windchill here in Chicago is -22 as I write this, with -30 on the table. I was in Mexico two weeks ago and the windchill was 80. The shivering, plus games that start at 7am, plus playoff football, mean you get an abbreviated newsletter this week.
Glad to see AJ Brown reading my latest interest rate thoughts. Now, if we could just get him to hang onto the dang ball…
Last Week This Morning
- 10T: 4.62%
- 2T: 4.28%
- SOFR: 4.29%
- Term SOFR: 4.30%
- CPI Inflation Data all measures cooler than expected
- PPI Inflation Data all measures cooler than expected
- Retail Sales m/m: 0.4% actual vs 0.6% expected
- Fed Speeches:
- Fed Williams: “The path for monetary policy will depend on data”, however he noted the economic outlook remains highly uncertain, limiting guidance
- Fed Barkin: “I do believe that I know the direction of travel, but I don’t know the destination”, with regards to uncertainty surrounding the impact of the Trump administration policies
- Fed Goolsbee: Sees continued improvement in inflation and is optimistic the central bank can tame price growth and have a “soft landing”
Inflation Continues to Take a Back Seat to Jobs
All good news last week on the inflation front. Headline CPI increased from the prior month, but that was largely due to base effects as well as just a few items (namely airfare and gas).
The takeaway remains the same – the inflation war is not yet won, but it is contained enough to focus on the labor market.
CPI has several components that feed directly into Core PCE, so economists always rush to update their PCE forecasts with greater accuracy. WSJ Fed-whisperer Nick Timiraos compiled some revised forecasts for the Fed’s preferred measure of inflation, and the m/m Core PCE is just 0.17%. That annualizes to just over 2%. For those crying wolf inflation, keep that in mind before sending me hate mail.
It’s not falling as fast as it was a year ago…and the Fed has to be cautious with the new administration’s policies…and the untapped productivity the TikTok ban may unlock…but that doesn’t mean rate hikes.
I still expect a lot of rate hike rhetoric out of the Fed to keep a lid on inflation expectations. There’s really no upside to signal more cuts right now, even if that’s what Jay$ expects to happen. Here’s one year inflation expectations, which have driven higher since markets really started pricing in a Trump win.
Assuming job numbers remain decent, we may see the Fed on hold all year. This would mimic the only soft landing in history (1994), when the Fed cut 0.75% and then paused for several years. I still think they cut this year, but don’t expect a lot of signals unless the wheels really come off.
Rates
I don’t think a March cut is totally off the table yet. It’s unlikely, but not 0%. Markets have a 28% chance of a cut on March 19th. In order for this to happen, inflation concerns would need to remain contained and a deterioration in labor markets. If January and February paint a weaker labor market, expect a Fed cut to be in play.
One and two year caps are down substantially on the year, but the recent uptick in inflation expectations has caused longer term cap prices to push back up. Despite this bump, we’ve seen a renewed interest in longer term caps (particularly with 5%-ish strikes that are about as cheap as they will get).
The long end should experience increased volatility depending on what the new administration does on Day 1, particularly on tariffs.
Q1 is typically the biggest quarter for Treasury supply, driven in part by preparing to pay tax refunds. This Q1 will be the biggest quarterly issuance on record – north of $800B. For context, last quarter was $546B. This will apply upward pressure on yields until we get to the other side.
Against that technical pressure, JPM’s survey of client net long/shorts shows plenty of appetite for a T10 at 4.75%. This is the single biggest reason I don’t expect the T10 to surge to 6%. It is a screaming buy relative to the alternatives.
Barring terrible jobs numbers, a significant drop in long term Treasury yields may not happen until Q2.
The Week Ahead
Pretty quiet data week, plus we are in the Fed blackout period ahead of next week’s FOMC meeting. That means Trump 2.0 Day 1 could have an outsized influence on rates, particularly anything related to tariffs.
Also, I assume Ohio State beats Notre Dame to complete the Ryan Day Redemption Arc and to drive me nuts.
