The blue line below is what the Fed is communicating per their DOT plot, on the terminal rate going to a range of 5.00% to 5.25%. The orange line is yesterday’s Fed Funds curve (following CPI). The market expectations for the Fed Funds rate is finally rising to the level of Fed communications (and actually slightly above it). The green line is the Fed Funds curve the day before the payroll report, less than two weeks ago.
Source: Bianco, as of 02.15.2023
This is a massive change in Fed expectations in just 12 days. We believe for the first time this entire hiking cycle, the market is pricing relatively close to what the Fed is suggesting. No more “pivots,” “pauses,” or “step downs.” The market is pricing a 100% probability the Fed will hike 25 basis points on March 22, to 4.75% to 5.00%.
Assuming the March 25 basis point hike, the market is pricing an 83% probability of another 25 basis point hike 5.00% to 5.25% on May 3 which would bring the rate to the Fed’s current communication target.
The Market Expecting the Dot Plot to Update… HIGHER?
The market is also pricing in a higher probability of another 25 basis point hike on June 14th. Yesterday, (post-CPI) the probability crossed above 50%. This is above the current Fed’s communicated target.
Source: Bianco, as of 02.15.2023
This goes contrary to the recent February BofA Global Fund Manager’s survey released yesterday morning, showing only 23% think the Fed will go above 5.00% to 5.25%. So, the market pricing detailed above has the terminal rate higher than 75% of the fund managers in this survey, covering 273 managers with over $750 billion of AUM and was conducted from February 2 to February 9.
Source: BAML, as of 02.14.2023
Higher Terminal Might be the Right Call
TS Lombard runs a diffusion index showing the January CPI data (percent of CPI sub-categories with 3M rates of change greater than their 12M % Change) that remains elevated and has been climbing since summer.
Source: TS Lombard, as of 02.14.2023
To underscore just how broad of an inflation problem the Fed is dealing with, here is the same chart covering the diffusion index since 1982:
Source: TS Lombard, as of 02.14.2023
Sticky Inflation Remains the Talk of the Times
The 3-month annualized core CPI ticked up to 4.6%, moving away from the Fed’s 2% target. And the Fed’s preferred gauge – core PCE inflation – will be slower to fall, given its smaller weight for still-sticky shelter, and different methodology for health care. This could confirm higher for longer.
Source: Piper, as of 02.14.2023
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