"Transitory is a Dirty Word"

Extreme supply and demand imbalances (globally) remains front and center. Last week in our segment with Fox Business, we highlighted the move in UK short end rates following the Fed's FOMC meeting. Certainly, the sentiment coming out of the UK and other global central banks has spilled over to the US market. 

The chart below: 2-year USD, EUR, GBP interest rate swap rates

We continue to witness extreme conditions across the globe: Supply chain, energy and labor. This latest US jobs number very symptomatic of continued conditions in the US. Ultimately, central banks are caught between a rock and a hard place. Look no further than the UK: rate increases being priced in and a currency which heads lower. In the end, with the repricing on global short end rates, central banks leaning more hawkish around the globe has lent to long end volatility as forward growth rates are questioned.

GBP and EURO 30-year Interest Rate Swap rates

You need to find levity amongst the tornado we are dealing with every day. Inflation talk is everywhere. Even Atlanta Fed President Bostic this week called "transitory" a dirty word (it is btw). The "inflation experts" have it all mapped out (wink), and for the Fed, their forecasts come gliding down to target (2%). Think of William Shatner on Blue Origin, returning right back for a big hug, all safe and "what a profound experience". The best yet perhaps, from the September FOMC Minutes on inflation this week:

"Total PCE price inflation was 4.2 percent over the 12 months ending in July, and core PCE price inflation, which excludes changes in consumer energy prices and many consumer food prices, was 3.6 percent over the 12 months ending in July. In contrast, the trimmed mean measure of 12‑month PCE inflation constructed by the Federal Reserve Bank of Dallas was 2.0 percent in July. In August, the 12-month change in the CPI was 5.3 percent, while the core CPI rose 4.0 percent over the same period" 

Dallas Trimmed Mean PCE Deflator

The Dallas Fed's "trimmed mean" inflation reading. Right at 2%. It's amazing. As we move a bit closer to the formalized taper, the Fed is going to hold onto transitory for dear life. It was even in the FOMC minutes from this week, although inflation was mentioned 79 times while transitory a mere 4: that's progress.

Inherently, the Fed believes in the global disinflationary forces before the pandemic hit and will don their best game face in the form of a "taper" to appease the inflation hyenas which are out in force. And the forces are real. The Fed's last bastion of dovish hope? Interest rates. And it's no secret. Get ready for the Powell, November, methodical, slow, boring, friendly & well telegraphed taper presser: there will be NO rate increases before their time!!! The BOE may have something else in mind, and lately so too does the US rate market as hikes creep a bit further in 2022.

Fed Fund probabilities provided compliments of Bloomberg analytics. Close to two hikes in 2022. Linear taper timeline: June 2022. Seems unlikely the Fed increases rates in 2022.

Where there is smoke, there's fire. The taper being the smoke and rate increases the fire. Jay Powell and the Fed have learned from the global financial crisis of 2008. Call it the language communication, the use of forward guidance and separation of asset purchase reductions and rate increases. To boot, a nicely minted 2020 Jackson Hole framework change. What the Fed didn't anticipate and discussed in our last Fed preview, was inflation preceding their desired employment gains. Although it's hard to think this labor market is not already tight.

Markets are testing the Fed. No surprise. With the headline inflation numbers showing little signs of abating, global central banks spooked out of their socks (boxed), Jay Powell looking like Superman with transitory kryptonite and taper imminent: why not. This is why the Fed drags their feet on asset purchase reductions. And this is what markets do. Ultimately, we get the taper next month, but we do believe the Fed will hold on to zero rates (or very close) for as long as they can. So, we do respect the market's creep further into 2022 on rate increases, but look for the Fed to continue their aggressive campaign to push back on liftoff.

5-year Forward, 5-year OIS. Averages 1.90% since 2016. Currently: 1.75%.

The FOMC Minutes- September 21, 22

 https://www.federalreserve.gov/newsevents/pressreleases/monetary20211013a.htm

Inflation: Upside risks remain the theme. But in light of this week's CPI and increases in the in Owner's Equivalent Rent:

Atlanta Fed President Bostic's comments about inflation becoming more "broad-based" and Richmond President (don't call me woke Larry) Barkin "There has been "some increase and broadening of inflation to other areas".

Fed Minutes: "Many participants pointed out that the owners' equivalent rent component of price indexes should be monitored carefully, as rising home prices could lead to upward pressure on rents. A few participants noted that there was not yet evidence that robust wage growth was exerting upward pressure on prices to a significant degree, but also that the possibility merited close monitoring"

CPI and Owners Equivalent Rent, Year over Year since 2000

Jobs: "With regard to the Committee's maximum-employment goal, participants considered the cumulative degree of improvement in the labor market since December 2020. In doing so, participants cited the progress recorded in a number of individual series:

"employment-to-population ratio, the unemployment rate, claims unemployment insurance, job openings, nominal wage growth, and increases in payrolls. Adding monetary policy accommodation at this time would not address such constraints or that the costs of continuing asset purchases might be beginning to exceed their benefits". TRUE! 

This Week's JOLTs: job opening and quit ratio still at record levels

Asset Purchases: We've been in the November camp for quite some time with the belief the Fed would wait for the September data: Treasuries and mortgages proportionately, & likely 10x5 and data dependent. Disappointing job number last week: but private payrolls decent, lower Powell bar, upward revisions, wages up and this week's CPI. For inflation: Fed's been clear: more than exceeded substantial further progress since December 2020. It compensates for employment numbers which have weakened, yet job demand which remains robust. 

Job Gains have leveled. But totaled 4.5 million since the Fed's Forward Guidance with the asset purchases, tempering to 500k a month during that period. Uneven, but cumulative.

Fed Minutes: The tapering path was designed to be simple to communicate and entailed a gradual reduction in the pace of net asset purchases that, if begun later this year, would lead the Federal Reserve to end purchases around the middle of next year. The path featured monthly reductions in the pace of asset purchases, by $10 billion in the case of Treasury securities and $5 billion in the case of agency mortgage-backed securities. Participants noted that, in keeping with the outcome-based standard for initiating a tapering of asset purchases, the Committee could adjust the pace of the moderation of its purchases if economic developments were to differ substantially from what they expected.

The stage is set for November. The Fed is late to the game of reducing emergency measures. If they begin with the NY Fed's schedule in November, in a linear world the taper would end in June of 2022. Another reason the creep for rate hikes further into 2022 looks aggressive.

 US Rate Markets

Since the Fed's pivot at the June FOMC, we've highlighted the cheapening of the 5-year part of the curve. It's happened in bull and bear fashion. From an outright perspective in 5-years, we've been bearish. 1% was a tested level in 2021 and violated, leaving considerable room toward higher yields back toward pre-pandemic levels with the market transitioning closer to taper, away from emergency conditions and eventual rate hikes. Ultimately, depending on one's view of the timing of rate hikes likely an opportunity, but the market has yet to firm.

In terms of US rate market direction: UST 10-year. The upper end of our multi-month range over the summer and recent break: 1.42%. And versus the most recent high and the projected upper end: 1.62%. Mid slightly below current levels. Good chart below highlights the strong double bottom over the summer around 1.12%. Also, very decisive range late 2019 and into pre-pandemic conditions of 1.50-2%. Neutral levels, but this week's long end auctions in the 10 and 30-year with 70% indirect bidders highlights continued end user demand. Global rate are and will remain in a lower rate regime. With that, we maintain a higher and steeper bias, looking for opportunities to sell into market strength.

Have a great weekend!