Post-FOMC Thoughts
Buy Bonds Now?
Today is all about getting the Paper Alfa house ready for Christmas. And there is tons to do; it’s a drill which I thoroughly enjoy doing every year. However, before the tree gets erected, I just wanted to send a quick update following yesterday’s FOMC meeting. I was wrong. Jay did not come out in a silver or blue tie; instead, he chose purple. I shall update the records accordingly. He is clearly more fashionable than I thought.
The good news is that the models worked like a dream in the run-up to the meeting (full update as usual tomorrow). Even though I thought that he would be leaning against current near-term market pricing, everything the market really cared about was the planting of those ‘24/’25 dots by 50 bps lower compared to their September projections. While Jay didn’t totally take off the probability for further rate hikes, everything the market heard was as loud:
The Fed's overall outlook for the economy and unemployment didn't change meaningfully from the September forecast. A slightly more benign outlook for inflation was the background that led policymakers to pencil in 3 rate cuts for 2024 and 4 in 2025. Markets now discount close to 6 rate cuts next year and another 3 in 2025. That’s more than 200 bps of cuts loaded into the front-end over the next two years. In my piece on Taylor rules and optimal control, I opined that a gradual move of inflation back to 2% would justify a policy rate of 4%, all things being equal. That’s not too far from the Fed’s median 2025 Fed funds projection of 3.6%. The Dec 25 SOFR implies 3.18%, which includes a fair share of a recession premium in addition to the Taylor rule dynamics. As such, would I load up on bonds here? The answer is no. I don’t know why they have chosen the path that has now even put in a small probability of a January cut and cemented the first full rate cut by March 2024. Justifying such pricing by inflation and growth dynamics alone will be hard to accomplish, in my opinion, given that we have even overshot a soft-landing scenario.
Our momentum model has taken us long bonds in early November at around 4.6% in US 10s. It’s nicely in the money, and there is no need to chase it. Yes, we have broken the 200 ema on yesterday’s move, and I’m sure plenty of latecomers will chase this rally further. I will be using further rallies to reduce my long bond short. Risk-reward and my above logic on pricing would dictate such a move.
As usual, I will follow up with the full chart pack in tomorrow’s Friday Paper Charts.
Best of Luck out there!
I´m not able to understand why markets are chasing US bonds here. A month ago they were talking about US yields to 6-7% and today they are buying like there´s no tomorrow at 3,9%, while I can only see that with this easing in financials conditions, the necessary adjustments for inflation downside will be avoided, forcing the FED to stop talking about rate cuts and even to quit the three cuts that they showed to us yesterday. One thought that comes to my mind too is: what was the need for the FED to announce the rate cuts yesterdya without achieving inflation target and further heat up the markets? Don´t they realize that is going against their targets (if really fighting against inflation is their target)? The only reason that I find is to finance the Treasury cheaper for the election year (as Yellen reminds us every day). It´s clear too that I´m a normie and a lot of things are beyond my comprehension. Thanks for this place.
I remember you shared a note on when to buy bonds that explained most of the return was after the first rate cut (presumably bonds moving to price in a deflationary slow-down). the price action so far, hasn't it been a bit unusual compared to past cycles? any views there?