Good Friday AM,

Today was the big data day of the week and it for the most part, it all came in stronger (or at least not weaker).

The details are below. Inflation continues to be sticky although I don’t necessarily believe it. Bonds started to take it hard as the futures market now show a greater chance of a fed rate hike in June than a pause. You may want to read that again. Two weeks ago, we were at a 99% chance of a pause, today we are closer to a 45% of a pause. I do think the Fed pauses but that change in sentiment alone will cause markets to move and move they have. We are now through the Fibonacci 50 (50% retracement) and if we don’t get the 10-yr back below 3.78% soon, the charts look very ugly. As it is, rates have popped up to the highest level since March. The selling will stop and I see the rebound coming but it has been painful and there’s no reason to expect the pain is over quite yet.

• Pers Inc 0.4 vs 0.4
• Pers Spend 0.8 vs 0.4
• PCE MOM 0.4 vs 0.4
• Core PCE MOM 0.4 vs 0.3
• Consumer Sentiment rev from 57.7 to 59.2

On the ever important debt ceiling, The House of Representatives left for its Memorial Day weekend recess with some progress but no deal in place to raise the nation’s debt ceiling, as the White House and top Republicans sought to agree on the central issue of government-spending levels. Negotiators are narrowing in on a two-year spending deal that would raise the debt ceiling for the same amount of time, extending it past the 2024 election. Leaders are hoping to reach and pass a deal next week ahead of a June 1 deadline, when the government could run short of funds to pay all of its bills on time, Natalie Andrews, Siobhan Hughes and Lindsay Wise report.

And just out, ATTOM’s Q2 2023 Vacant Property and Zombie Foreclosure Report has found that 1.3 million (1,285,633) residential properties in the U.S. remain vacant—a total that represents 1.3%, or one in 79 homes, across the nation.

Finish it off with a good piece from Bloomberg on rate hikes and rate cuts.

One of the biggest question marks in bond markets now is when, why, and how much policy makers will eventually cut rates, now that we’re nearing the end of the tightening cycle. Two weeks ago, markets were preparing for multiple easings this year, but those hopes are fading as the economy shows signs of still being hot. There might even be at least one more hike ahead. US bonds maturing in 2024 and 2025 have the most risk from a shift upward in expectations for future yields.

• Data released this week show the US doing better on employment and growth, while inflation is also marginally higher. At the margin, that increases the likelihood for a longer pause and even a rate hike down the line.
• Fedspeak is universally hawkish right now as a result. I would characterize the communication as suggestive of a hawkish pause. With the rate hike train nearing its end, discord is now greatest among Fed officials about the best policy path forward. The easiest way to get hawks and doves rowing together, now that the real Fed funds rate is positive and inflation is receding, is to switch from hikes to a pause. That would kick the can down the road, and allow for data to steer the Fed to a clearer consensus.
• The market has been taking this on board, with Fed fund futures now pricing in less than 1 1/2 cumulative quarter percentage point cuts by January 2024. A week ago, that level was 2 1/2 and two weeks ago, it was nearly 4.
• But rate cut expectations remain. You can see the rate cut expectations in the divergence in price action between the Sep 2023 and the Jun 2024 Fed funds futures contracts. Starting about November 2022, speculation on Fed rate cuts caused the Jun 2024 to rise in price while the Sep 2023 contract remained in a tight range, except during the regional bank turmoil. The September 2023 contract is now back to the same level in November as when the rate cut hopes first began.

• The Jun 2024 contract, on the other hand, is very elevated by comparison. That’s based on two common assumptions. The first is that the US economy will be in recession by then. The second is that the Fed will cut in response. But there are reasons to doubt both of these expectations, in particular expectations for more easing.
• First, while the bar is high for another hike, it is also high for a cut, at least in the medium-term. We will see that in the summary of the Fed’s economic projections in June. I expect the 2023 year-end Fed funds rate to remain the same but for the 2024 rate to perhaps go a bit higher based on an upgraded 2023 outlook for employment and GDP growth.
• That makes near-term Fed fund futures pricing look realistic. But Fed fund futures still pricing in 1 1/2 cuts by Jan 2024 look unrealistic, setting us up for additional losses for the Jun 2024 as the market is forced to price out those cuts.
• The losses are even more likely when you consider that we’d have to have a big recession in 2023 to crystallize cuts by Jan 2024. The Fed has penciled in a rise in unemployment to 4.5% by year-end without a rate cut. So even if we have a mild recession in 2023, no rate cuts are coming. And perhaps, we won’t see easing until the unemployment rate rises to 5%.
• On the Treasury curve, this translates into the greatest losses in the 12-month maturity and the year thereafter as the market prices out cuts in 2023. Any longer-term rates are mostly a reflection of expected inflation, which has not become unanchored.

• The 1- and 2-year part of the curve is where market expectations are most out of whack with likely rate outcomes. The pain points for the market will be there.

Please remain safe and stay healthy, enjoy the holiday weekend and first, make today great!