Thread by @RyanMiller_TE

Have US Treasury yields finally peaked? 🧵 1/x

#TLT $TLT #bonds #Fed #recession #StockMarket #investing #trading #inflation

They may have, but there are still significant risks. The market has been driving yields lower by pricing in a Fed pivot, NOT recession. First, why is the market pricing in a Fed pivot? 2/x

Last week there was a miss in the CPI inflation reading. Headline CPI fell from 8.2% to 7.7% and Core CPI fell from 6.6% to 6.3%. The market interpreted this as further evidence that Dec will be the Fed's last rate hike and a pause/pivot is near, allowing for a soft landing 3/x

How do we know the market is pricing in a pivot? The Eurodollar futures curve prices in future expectations of the Fed Funds rate. Expectations have shifted lower over the past two weeks. Blue is where we are today vs orange is where we were the day before the FOMC meeting 4/x

So the market is expecting a lower peak Fed Funds rate and faster rate cuts in the future. Since the expectations of Fed Funds has shifted lower, it has shifted the US Treasury curve lower with it 5/x

Furthest blue line to the left is the FOMC day. The next blue line to the right is post-CPI reading. As you can see, since the CPI miss yields have fallen sharply, in line with the Fed pivot narrative 6/x

The market believes a Fed pivot means no recession (save this for another time), so it has bought bonds to front-run Fed rate cuts and bought risk to front-run an economic bottom/soft landing. How do we know the market is not pricing in recession? 7/x

Credit spreads since the last FOMC meeting 2 weeks ago have tightened back under 200bps. The market is pricing in less credit risk today, than it was prior to the hawkish Fed meeting. Credit spreads rising towards 300bps would be the credit market pricing in recession 8/x

Nominal growth expectations (SPY/TLT) are still elevated. Cyclical growth expectations (IWM/TLT), although coming down, are still elevated. Also, corporate credit is outperforming long-duration bonds (VCLT/TLT). Equity market is not pricing in recessionary conditions 9/x

Despite the equity/credit market pricing in a Fed pivot and an economic rebound, the bond market has not wavered. The 2s/10s yield curve went from a 50bps inversion on FOMC day to now a 66bps inversion, post the miss in the CPI reading. Extremely recessionary pricing 10/x

The risk going into the Dec FOMC meeting on the 14th is that the Fed is just as hawkish or more hawkish than the Nov meeting. Powell can shift the Fed Funds expectations higher, which in turn would shift the US Treasury curve higher - higher nominal yields 11/x

What are the reason for a hawkish Fed? Remember the Fed has a dual mandate: price stability and maximum employment. So let's look at those two 12/x

Despite the miss in last week's CPI data, both headline and core CPI are nowhere near the Fed's 2% target. Headline is still at 7.7% and core has been stuck above 6% for all of 2022. Not a reason to pivot 13/x

The unemployment rate is at 3.7%, near historical lows. Nonfarm payrolls still elevated relative to its long-term average 14/x

Initial Jobless Claims are low, around 200k a month. Prior to the 2007 and 2000 recessions, claims were already above 300k. Wage inflation has peaked, but still well above the long-term average 15/x

The Fed is going to look at the headline numbers in employment and determine the labor market is still to tight to consider a pivot. This is the big risk heading into the next FOMC meeting which is less than a month away 16/x

And since yields have fallen because of a Fed pivot narrative and not because of recessionary pricing, the Fed can easily shift Fed Funds expectations higher, and thus the US Treasury curve higher with it 17/x

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