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Overview of U.S. Rates Market and Upcoming Policy Decisions

Jay Barry highlights the quiet week in U.S. rates markets with mixed data and dovish central bank developments. Emphasizes key upcoming policy events, including the Treasury’s quarterly refunding announcement and the FOMC decision, referring to them as crucial for the U.S. rates markets.

Transcript
Jay Barry: You're listening to At Any Rate, J.P. Morgan's global research podcast, where we take a look at the story behind some of the biggest trends and themes in fixed income, currency, and commodity markets today. I'm your host, Jay Barry, co-head of U.S. Rate Strategy and chief U.S. government bond strategist at J.P. Morgan.

It's been a relatively quiet week in the U.S. rates markets with yields re-pricing a bit lower at the front end and a bit higher at the long end amid some sort of mixed bag of data and dovish developments across some other developed markets, central banks. But overall, it's been a very low volatility move after some stronger moves to start this year. In essence, this might be because market participants are catching their collective breaths ahead of key policy decisions next week. And on that note, there's a major amount of policy risk ahead of us with Treasury's quarterly refunding announcement and the FOMC decision both due on Wednesday. One could call the confluence of these policy decisions a Super Bowl for the U.S. rates markets, falling just 10 days before the actual football game itself. The combination of a major pivot from Treasury and a dovish FOMC decision on November 1st kickstarted a 100 basis point decline in 10-year yields over the following two months. A casual observer might say there was some policy coordination between fiscal and monetary authorities as the Treasury displayed newfound flexibility, slowing the pace of its coupon auction increases compared with its August announcement, and also guiding the markets towards just one final round of increases. In a similar vein, the Fed's focus on tightening and financial conditions led markets to rule out the probability of any further rate hikes, and the markets firmly concluded that the fastest tightening cycle in 40 years had come to a conclusion. With that in mind, I've got a great guest today, Chief U.S. Economist Mike Feroli, to discuss the risks around next week's policy events. Mike, thanks for joining.

Mike Feroli: Thanks, Jay. Good to be here.

Federal Reserve’s Upcoming Meeting and Economic Indicators

Mike Feroli discusses expectations for the Fed’s policy statement, anticipating a shift to a neutral stance. Highlights recent economic indicators like core PCE data and labor market trends, emphasizing their influence on the Fed’s decision-making process.

Transcript
Jay Barry: So let's dig right in, and I just want to roll forward to next week. So the Fed meeting, we have a statement in a press conference, but it's a meeting without an SEP. And to me, there seems like there's a bit of tension. As you noted in the morning note after the core PCE data, it's been running 1.9% on an annualized basis in the last half of 2023. And I'm sure this is a welcome development, but the rebalancing in the labor market's been pretty slow. And if anything, you just revised your growth forecast higher today from 1.25% to 1.75% for the first quarter after the spending data we got. At the same time, we've had some other developed market central banks, like the Bank of Canada and the ECB, nudge their guidance in a more dovish direction in the past few days. So as we use this as a backdrop, what are you expecting out of the statement and out of Chair Powell's press conference next week, Mike?

Mike Feroli: So, thanks. I think for me, the most important thing will be the statement and what kind of a forward guidance we get in that statement. For about six months now, the statement has talked about, has basically had what we would call a bias to tighten. So it has talked about what could prompt additional further policy tightening. That got softened a little bit in December to talk about any additional policy tightening. And we think that goes to more of a neutral statement or neutral bias or no bias, I guess you'd say, in next week's statement. So not tipping a hand toward either hiking or tightening, hiking or easing or cutting at the subsequent meeting. Powell has been talking about a desire to get policy to a place that's sufficiently restrictive. And given what we've heard in the inter-meeting period, it sounds like they now believe policy is sufficiently restrictive. And so I would expect to see that reflected in the statement. I think if they do want to push back against expectations of imminent easing, they could also use another phrase that Powell has been noting in his press conferences of the last two months, which is that policy will remain restrictive until the Fed, so long as the Fed, until the Fed gets confidence that inflation is on a path to sustainably be at 2 percent.

So now to your point, Jay, you're right that over the past six months we've been running very close to 2 percent. Over the past year, we've been running closer to 3 percent. So I think the Fed and Fed officials may not yet have confidence that that 2 percent we've seen over the last six months is what we can expect to see over the next six months, in the next year, particularly as you mentioned, the labor market remains pretty tight. And we expect to see that again next Friday. You mentioned the Super Bowl. I guess after the Super Bowl, we're also going to get payrolls on Friday. And we think you're going to see there that average hourly earnings are still running close to 4 percent on a year ago basis. A number like that, I think it's going to be hard to have complete confidence that you're on that sustainable path to 2 percent. So I do think they're moving, again, moving to a neutral bias, taking steps toward eventually easing or cutting, but not yet ready to sort of signal their hand at that given these factors that I mentioned may limit their confidence that we're ready to declare victory.

Inflation Language and Growth Prospects in Fed’s Statement

Mike Feroli analyzes potential changes in the Fed’s statement regarding inflation, suggesting the language might remain cautious. Forecasts adjustments in the growth description based on recent economic data, while considering the political implications of changing inflation language.

Transcript
Jay Barry: So a true neutral bias, as you said. Now one other question for you, and you've had this whole discussion about inflation and you mentioned it in your preview this morning, that you think the couching of the inflation language in the statement could be up for debate as well. So can you just sort of talk a little bit more about that?

Mike Feroli: Yeah, so the statement had read that inflation has eased but remains elevated. If you really wanted to celebrate the six-month annualized number, maybe you would soften that. I think they won't, in part because for better or worse, year-ago conventions are what is established and I don't think with the year-ago number on core, at least running close to 3 percent, on headline a little lower, that it's from a political and public messaging perspective, I don't think it's wise to signal that you're kind of comfortable with where inflation is on a year-ago basis. So I would think they leave that section of the statement unchanged. There are some other aspects of the growth description that probably will get changed. The December statement sounded pretty cautious essentially on fourth quarter growth. I think after what we saw on Thursday and Friday mornings, that can be a little more sanguine. And then there's a question about the statement has tighter financial conditions as a headwind of growth. You know, in December we kind of thought that might come out. It didn't. I still think there's a case for that to come out next week but being wrong last month, I'm a little cautious on how hard I would hit that point for looking for that next week.

Anticipations around Quantitative Tightening and Balance Sheet Adjustments

Jay Barry and Mike Feroli anticipate that the upcoming FOMC meeting will include preliminary discussions about QT but do not expect any immediate conclusions or decisive policy changes. Feroli predicts that while the meeting might not yield firm decisions on QT, it’s likely that Jerome Powell will comment on the matter, suggesting that the Fed is actively considering adjustments to its QT policies.

Transcript
Jay Barry: Thanks for that. And I think it's just interesting from a market perspective that you talk about how it was a bit more cautious on growth late last year back at the December meeting, but that things look a little bit better right now. And it's just telling that we've actually repriced the Fed pretty considerably since we've started the year. I think at the trough in late December, markets were pricing that the Fed funds rate later this year would sort of trough down at around 370 for year end 24. And right now it's a little bit closer to 4%. So we have backed up somewhat in recognition of the strength in that data. But thanks for the sort of detailed dive on the statement right there. The other thing that I want to talk to you about and ask your opinion on is, you know, you and I have been speaking a lot and we've written a fair amount on this this month to date is QT. So the December minutes, there was that discussion from several participants about starting the conversation on slowing and stopping QT. Since then, we have seen commentary from Lorie Logan, from Chris Waller, from John Williams, all talking about the balance sheet here, probably the three people you'd most expect to hear from on that topic. What are you expecting out of QT and will we hear anything from Powell in the press conference on this?

Mike Feroli: Yeah. So after those minutes, as we discussed, we felt that was kind of took their hand to them having a more detailed discussion at this meeting. You know, perhaps staff presentations of options for slowing and then stopping QT. But we would expect those to be preliminary discussions. So we don't expect any firm conclusion and thus nothing in the, certainly in the FOMC statement. I do think we could get some remarks from Powell that this is something they are starting to consider, but that no conclusions have been reached. I wouldn't personally expect him to go into much more detail, particularly if it's just, you know, staff presentation of options. But I would expect to see that if that indeed takes place, to see that in the minutes, which will get three weeks hence. So I wouldn't look for any firm conclusions. I think more likely we see those in the minutes. And then if we do get any, you know, our best guess is that we actually have firmer conclusions and decisions coming out of the March meeting.

Jay Barry: Yeah. And again, just to hit that home, this means that the timeline from that perspective at least should look a lot like 2019 with respect to the evolution of the debate there.

Mike Feroli: Exactly.

Bank Term Funding Program (BTFP) Expiration and Its Implications

Jay Barry and Mike Feroli discussed the Federal Reserve’s Bank Term Funding Program (BTFP), focusing on the strategic timing and rationale behind its expiration announcement. They speculated on the reasons for the late announcement, considering its potential arbitrage-driven take-up by banks. They also examined how the BTFP’s termination was communicated, separating it from broader monetary policy decisions to avoid conflating it with a policy tightening signal.

Transcript
Jay Barry: All right. So one more question for you. We've talked rate policy, inflation, growth, and QT. Earlier this week, the Fed announced that the bank term funding program, the BTFP, which was instituted last March around the regional bank failures, would expire as scheduled on March 11th. Now, this wasn't really surprising to market participants, considering that it was established under the Fed's emergency 13-3 facility authorities. But why did it wait until this week to make the announcement? Could it have made it next week at the FOMC meeting? I know it's a board decision and not a committee decision. Why do you think it came out so late in the evening this week? And I know now that while it's also given us the insight that the program will end in six weeks time, it's also repriced the facility. So it's now being offered at IORB, which is about 540, compared with the prior rate of one euro OAS plus 10, which is about 50 basis points lower right now. So why do you think this decision was made this week?

Mike Feroli: So I've seen very speculation as to why it came out 7 p.m. on a Wednesday. Hard to say… one could also say, why didn't they make the decision last week or the week before? We had, over the past several weeks, seen an increasing take-up of this facility. And there was a lot of speculation, given that we hadn't seen other signs of distress, that the take-up was driven by banks arbitraging the lending rate against IORB. So why not wait until next week? I think it would just be one more week of giving away free money, which was not the intent of the program. So I'd kind of flip it around and say maybe they should have done it earlier. But in any event, as you point out, it was a board decision. I think if you do it at the FOMC meeting, it might risk conflating that decision with a monetary policy decision. So I think doing it away from the FOMC meeting makes a lot of sense if anything, I probably would have done it earlier.

Jay Barry: That's a great point, because otherwise this looks like a tightening of monetary policy if you conflate those two together.

Treasury’s Refunding Announcement and Its Market Implications

Jay Barry predicts a lower market impact from the upcoming Treasury refunding announcement compared to previous ones, thanks to the Treasury’s past guidance and stable auction sizes. Barry anticipates a relatively stable fiscal outlook and considers both potential upside risks from capital gains taxes and offsetting risks from tax cut extensions. Barry also factors in the earlier end date for QT, which could mean a significant reduction in Treasuries returning to private hands. His perspective indicates that any changes in Treasury issuance might be managed through adjustments in T-bill issuance, rather than significant shifts in overall fiscal policy or market dynamics.

Transcript
Mike Feroli: So Jay, why don't we turn to the other policy event of the week, the Treasury refunding announcement, which is Wednesday morning before the FOMC. Last two refunding announcements have been market moving events, which aided the rapid rise in rates nearly fall and the sharp decline we saw over the last few months. Should we expect next week's announcement to be similarly dramatic?

Jay Barry: So Mike, I think there's a lot of recency bias to this because of those very volatile and market moving events that you talked about. But in essence, I think that this is going to be a much lower volatility event for the markets than we've seen over the last six months for a few reasons. I think the first is the Treasury gave us relatively strong guidance back in November. Certainly, I think it was a little bit unusual relative to our prior experience modulating the pace of increases versus what it had done in August. But it also gave us a pretty firm commitment that there would be one more round of increases next week and that auction sizes would likely remain stable by the time that this set of increases were done.

So against that backdrop, I'm kind of using that as my baseline and saying what else could perhaps change that baseline view? One, I think we need to think about fiscal. And you and I have been going back and forth on fiscal here recently. You've got a fiscal year 24 deficit of 1.675 trillion and there's risks probably coming from both sides. I think on one hand, the everything rally in the last couple of months of last year means that there's some upside risk to capital gains taxes versus that baseline. But at the same time, as you've mentioned that the likelihood that you're seeing these tax cuts extended, that probably is an offsetting risk in the opposite direction. So the fiscal outlook seems to be pretty much unchanged. And the one new variable over this period is that we have brought our QT expectations forward for its end date. So in essence, at least in our baseline forecast, that earlier end date to QT probably means 300 billion less in treasuries coming back to private hands this year. And that's not a change in net issuance for treasury, just where it's going. But I think that can be kind of funded by reduced T-bill issuance. So at my baseline, I look for a treasury to deliver what it said it would deliver back at the November refunding, which should mean that this should be a much less market moving event for the markets than it was back in either August or November. And I think it stands out too, because to me, in the time that I've been watching treasury finance over the course of the last couple of decades, I think it's rare to see the markets react so aggressively. And probably the only prior time I can remember such an aggressive reaction coming out of a refunding was going back to 2001, when the treasury department cut a 30-year bond and discontinued issuance without any prior notice. So our baseline is unchanged from the guidance we received. We'll see what's said around the policy announcement and all the documents that come out in the morning, but we'd expect that this would not be sort of the similar amount of volatility to what we observed in August or November.

Current Rate Levels and Yield Curve Expectations

Jay Barry evaluates current treasury yields and rate levels, considering them fairly valued based on Fed policy expectations and market indicators. Discusses potential shifts in the short-term rates and the neutral investor positioning, projecting lower intermediate yields and a steeper yield curve at the long end over the medium term.

Transcript
Mike Feroli: Right. So, okay, so in the context of that, how are you thinking about rate levels and the curve here?

Jay Barry:Yeah, so generally speaking, we look at what's happened in the year to date and rates have backed up, yield curves have steepened. By most estimations, I think treasury yields are pretty fairly valued here. Looking at 10-year yields somewhere in the vicinity of 415, they're priced in line with what the market is implying for the pace of Fed policy adjustments over the next three to six months, as well as the market's longer term growth and inflation expectations. So I think we're kind of appropriately priced, but to the extent that the market continues to price in a bit of an earlier start to easing than the modal forecast that you've talked about, which is a first ease in June and five eases after that, there is a risk that we could see the very front end back up if we get our delivered policy outcomes next week on Wednesday afternoon. But I look at it, I think that would be more a very short end story and really less reflective of what's happening in the intermediate sector.

So given how much rates have backed up this year, we feel a bit more comfortable with where rate levels are right now. And if anything, we had been getting signals late last year that investor positioning dynamics were long enough, that's exposed enough to rates moving lower, that there was a risk from a technical perspective. If positions weren't wound, rates would need to move higher. And in fact, over the last six weeks, as rates have moved higher from their trough, we've noticed that investor positioning has become a lot more neutral. So our weekly treasury client survey now is right in line with where it's been over the past year. And even more interestingly, the share of neutrals in that survey, which was last taken on Tuesday, are at 71%, which we haven't seen a share like that since last spring. And it's in kind of the 97th percentile. So I think it shows while active market participants embrace the move to lower yields over the course of the fall, as we kind of got to a more extreme level, they've backed off and they're probably waiting to get these policy pronouncements out of the way on Wednesday. So in the context of valuations looking pretty fair, and the positioning looking pretty neutral, still feel comfortable over the medium term that intermediate yield should be declining as we approach the first cut, which is sort of the traditional dynamics, and that the yield curve should continue to steepen. Though we'd note that the yield curve as it steepened back out over the last few weeks, it's put it right back in line with where it should be. I think there was an overwhelming amount of demand for duration at the end of last year, which produced an artificial sort of shift lower in the term structure. And now the curve is more appropriately sloped to what we know. So while we've lost the relative value component to curve steepening here, and we're probably very near term stuck in a range, the medium term outlook for the Fed to begin cutting sometime in the next five months is supportive of the curve steepening. So I think on margin, we from here still support lower intermediate yields and a steeper curve particularly at the long end.

Well, Mike, I don't think we can cover anything else. We've gone over in exhaustive detail what we expect between 830 on Wednesday morning, 2pm and 2.30 on Wednesday afternoon. And I'd just like to thank you for joining us. And 8.30 Friday morning. Oh, 8.30 Friday morning. I'm sorry. I'm just so myopically focused on Wednesday, the Super Bowl, so to speak. But anyway, Mike, thanks for being with us this afternoon.


Disclaimer: Stay tuned for more episodes of At Any Rate, JP Morgan’s global research podcast series. This communication is provided for information purposes only. Please read JP Morgan research reports related to its contents for more information, including important disclosures. Copyright 2024, JP Morgan Chase and Company, all rights reserved. This episode was recorded on January 26th, 2024.