122 bps of Fed rate cuts priced into 2024? Do we fade the recent dip in UST Yields?

"Everything that was good for the markets yesterday is no good for it today"

Yields on US Treasuries moved sharply lower and the US2s10s bull steepened by 14 bps. The moves were driven by soft PCE readings with headline number at 0.00% mom and Core PCE prices rose 0.20% mom, soft spending and income growth, upward revision to Q3 GDP to 5.20% and an Initial Jobless Claims data which showed job market holding relatively well. Dovish Speech from Chair Powell at the end of the week pushed the momentum into the close. The economic release supported a soft landing scenario where in unemployment rate does not go drastically up and growth does not go in negative.

The data along side a softening inflation print from EZ 2.40% yoy Nov, Germany 2.30% yoy and lower crude oil prices saw a marked downward shift in Fed Fund pricing. The market is now pricing in 122 bps of cuts in 2024 which is the lowest in the last 3 months. Far out into the last 1 year, events around SVB Collapse, Stress in Regional Banks and concerns around commercial real estate drove the move lower in Fed Fund Pricing. This time around markets are bracing for a soft landing. According to a paper by Federal Reserve Bank of St. Louis, the forecasts for PCE prices Q4/Q4 2024 are at 2.40%. As per the Sep 2023 Fed projections, PCE prices and Core PCE prices are seen at 2.5% and 2.60% respectively. Since latest headline PCE data came in at 3%, the trend is seen lower and if the projections were to materialize, assuming a real rate of 150 bps we could see 2024 FFR at 4% which is what the current pricing indicates.

I did an analysis on the peak and trough pricing of Fed Fund Futures implied rates over a 3m month and 1Y horizon.

If a credit event or say a hard landing scenario is to materialize the pricing could shift materially lower. But at the current juncture, the current pricing seems appropriate. Any dips without a commensurate data deterioration, could offer opportunities to fade the move.

It would be prudent to be mindful of the wide divergence among market participants on the Fed Funds Rate at end 2024

Goldman Sachs 5.25%

Bank of America 5.00%

Bloomberg Economics 4.75%

Morgan Stanley 4.50%

Median 4.50%

Wells Fargo 3.75%

UBS 2.75%

4.35% on the 2Y and 4.05% on the 10Y are important support areas.

Let me know what you think by posting your comments.

Comments

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