Fed Still Failing to Convince Investors

  • Both 10yr and 30yr Treasuries are having a hard time escaping the gravitational pull of 3.50% yields and that’s where both find themselves this morning despite a week full of first-tier information. 3.50% has become a landing spot since early December, and after the Fed it remains so again. Currently, the 10yr is yielding 3.54%, and that’s up from a 3.43% low yesterday after the weak Retail Sales Report.  Thus, is the strength of 3.50%.


  • Meanwhile, the 2yr has had quite the week, reaching a low yield of 4.16%, prior to the Fed rate decision, spiked to 4.31% following the rate hike and currently sits at 4.28%, off 2/32nds in price. It seems that 2yr investors either (1) don’t believe the Fed gets to their latest terminal call of 5.00% -5.25%, or (2) if they do, they won’t be staying there long.


  • Despite the Fed’s updated forecasts for rates and the economy, and the hawkish rhetoric in the press conference,  investors still believe the Fed will be cutting rates next year and not waiting until 2024 as the dot plots imply. Investors still see a terminal rate near 4.89% with more than 50bps in cuts by year-end 2023. That’s about where they were before the Fed meeting.


  • We had mentioned some time ago not to expect too much nuance in Fed messaging until they get close to their terminal rate and that is what we continued to see on Wednesday. Investors were perhaps expecting to hear some modest acknowledgment, and reflection in the forecasts, of a cooler CPI in October and November, and cooler PCE numbers for October (November PCE numbers are due next Friday). That really wasn’t the case. The inflation forecasts seemed to be made before the November CPI numbers despite Powell saying they were. And the language in the press conference seemed to overlook most of the recent good news on inflation and focused more on the continued tight labor market.


  • The Fed knows the heavily weighted owner’s equivalent rent component lags and that it will begin to reflect weakening rent and housing prices at some point next year. The Fed knows goods prices are rolling over on a host of sectors, and while the service sector ex-housing increased in November the increase has been trending lower over the last two months. Lots of positive comments could have been made on the inflation front but we didn’t hear much of it.


  • Expect the hawkish Fed rhetoric to continue into the new year, as they continue to try and jawbone investors towards their latest rate forecast and attempt to keep financial conditions tight.  They will get the December CPI numbers prior to the February rate decision (in addition to the November PCEs) and if they continue cooling it will get harder for the Fed to keep on with the hawkish-only rhetoric one more time.


  • Investors seem to be wise to the Fed’s game of tough talk, thus, the reluctance to price in anything close to the Fed’s forecast. The market sees a Fed that, if true to their word, will hike into a recession and will have to backpedal in a hurry once growth contracts. On the other hand, investors could be expecting the rhetoric to soften as the final rate hikes are put on, and as the latest hikes make their way into a slowing economy and softening inflation. It will make for an interesting first quarter of 2023, that’s for sure.


Agency Indications — FNMA / FHLMC Callable Rates

Maturity (yrs) 2 Year 3 Year 4 Year 5 Year 10 Year 15 Year
0.25 5.07 4.83 4.74 4.72 4.79 5.25
0.50 5.05 4.80 4.68 4.60 4.65 5.14
1.00 5.05 4.77 4.65 4.56 4.56 5.01
2.00 4.75 4.59 4.48 4.44 NA
3.00 4.44 4.38 NA
4.00 4.33 NA
5.00 4.30 NA
10.00 NA

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Published: 12/16/22 Author: Thomas R. Fitzgerald