Dec '24/'25 Fed Funds is back to where it was before ZIRP redux madness started in the 1H!

Reaching 170bp of cuts in 2025, we now sit at only 70bp, not even 3 cuts in 8 meetings.

Short-end is as cheap as it ever has been in the post 2022 "new world"...

1/ 2/ ... as long as you think the Fed stays in a cutting cycle.

That end 2025 point is just under 4% now, compared to 3.5% well before the Fed started with that 50bp cut

Buy the rumour, sell the fact is still king

US 3Q GDP - banger headline with weakening composition

Nom: +4.6% 🔽
Real: +2.83% 🔽
Real ex Exp/Inv: +3.56% 🔼
_______
PCE: +2.46% 🔼
Govt: +0.85% 🔼
Res I: -0.21% 🔽
Biz I: 0.46%

Absolutely no recession signal, but detracting resi investment being offset by govt a concern

1/ 2/ The US is still a 3% real, 5% nominal economy.

Consumption, the largest component, has continued to trend up from the fiscal hole of 2022.

The current economy will perform in-line with the 10y average (dotted line). This is your base for real GDP growth.

TRUMP and the narrative for the 10y bond

In eco terms MAGA summarized:
- Trade deficit is too big, make it smaller
- Govt spending is too big, make it smaller
- US should lead in eco growth, so cut taxes to keep budget deficit and hope lighter regs help

Yields up or down?

1/ 2/ Taking the total of all the election promises I think these 3 points summarize the bulk of the rhetoric from Trump and the crew around him.

Base case unchanged policy was that long rates are too low & the curve is too flat. This is explained below.

macroisdead.com/p/as-a-portfol…

Despite the presence of skyrocketing govt debt charts, average "new money" growth continues to moderate from the heady days of 2022/23.

Oct actually shows a contraction in new debt.

Model still pointing to more downside vol in the S&P.

1/ 2/ Moving average should balance out to about $150bn/month eventually, but the latest print has caused a downturn in the indicator.

I've been vocal about staying away from US 10y longs.

2s10s is too flat, if you want to be long just buy short-end.

BUT how much do curves need to steepen for it to be attractive as a long (for lower rates or portfolio protection)?

1/ 2/ The chart above isn't my prediction, but is priced into the forward curves.

I.e. if the Fed were to cut as the SOFR curve to the end of the cutting cycle (roughly Dec-2025), and the 10y remains where it is, the curve will steepen to +0.74% mechanically.

This is priced in.

The last payrolls print highlighted that we are still in the 3rd act of US rates underperformance v EU:

1st act: US hikes faster post pandemic
2nd act: EU catch up with rate hikes/US tech turbulence
3rd act: Sustained superior eco perf makes it harder for Fed to cut ->

1/ 2/ The chart above is a comparison between the Dec-2025 SOFR and EURIBOR contracts. A falling level means US rates are underperforming (i.e. rising faster than EU).

X-market rates tend to range trade in regular waves.

Why do vol markets blow up?

The 5th Aug carnage was attributed to the "yen carry trade", but I think this is just macro trying to be smart.

While we can trace it back to the Nikkei, the conclusion is that the event itself is random, necessary and impossible to avoid.

1/ 2/ Some background.

The NKY was off by over 11% in the weeks preceding the 5th, with USDJPY off about 5% over the same period.

This was after a considerable period of quiet, with both the SPX and NKY grinding up with no vol over Jun & Jul.

BoJ & Fed and USD and then worry.

Today's PBOC actions give more panic feeling than a Fed 50bp.

Slow motion slowdown, deflation & de-leveraging becomes more worrisome when you introduce shock & awe...how bad is it?

View in charts (long one sorry)

1/ 2/ In a nutshell:

1. Post-pandemic slow in consumption & property partially offset with aggressive exporting of excess manufacturing capacity

2. Property related shortfalls in LGFV revenue is being managed, partially with a large fiscal deficit which hasn't helped the consumer

Tools being used to extend the business cycle now were once implemented only in economic crisis.

By breaking the limits, it seems like the goals of these institutions is to keep the US in constant expansion.

Equity markets love it too, as economic volatility has plummeted.

1/ 2/ Changes in underlying volatility of the economy (as measured by hard data), push up asset prices and encourage more leverage (which pushes up asset prices).

Measuring eco vol can be done as simply as measuring the range of nominal GDP.

The "25 or 50" discussion is painful.

Why?

1. There is logic for a direction to rates, but hardly ever one for individual moves.

2. Market pricing has a feedback loop with the Fed.

3. Hindsight doesn't make the move obvious.

1/ 2/ Every cycle this century has started with a 50bp (ex 2019).

Proof the Fed is always behind the 8-ball? Maybe.

Enough to start this one with a 50? Depends on how they view the current employment trend.

If you think they are worried, 50 is a great bet based on the past.

Keep an eye on this trouble maker - Nikkei futures traded weak in the overnight session despite stability elsewhere in equities

USDJPY looking just as precarious...

1/ 2/ It's managed to avoid the headlines so far without a sure break lower but expect it to make some news this session I'd say

Z4 SOFR has reversed the "game changing" NFP. I think pre-NFP levels act as support here, but the markets schizo approach to perceived recession risks are making both long & short vol strategies underperform.

Short-end sell off => curve flattens => equities rip higher

1/ 2/ 2 yr future back to pre-NFP levels...

The Japanese horror show today (down 12.6%), shows that it isn't about the direction of rates, but the vol a turning point produces.

All started with US CPI which shifted the market on rate cuts. Rates bid, USD off hard, shoulders tapped, risk unwind.

1/ 2/ Short vol/gamma positioning must be way bigger than everyone thought.

Right now we are tracking about the same as 2018 volmaggedon, with gamma trading measurably worse (esp. NKY)

As a buy & hold portfolio allocation, bonds really suck right now.

If the economics deteriorates quickly, bonds:

* Won't protect your portfolio;
* Won't profit more than leveraged short-end

All of this relates to how & why the curve is inverted.

1/ 2/ The 2/10y curve was inverted because the market always expected short rates to come down due to inflation subsiding + being long for portfolio protection.

In reality, the market could never price a normal yield curve because it was never going to believe inflation would stay.

US real GDP prints another solid qtr at +2.74% ex-inv/exports.

3 q's of near identical growth that have different composition - this month residential investment slowed and was made up for by accelerating non-res fixed inv and government...of course.

Don't bet on recession.

1/ 2/ After a slump in govt contribution last month, it's picked right back up to its +0.5% previous level.

Huge deficits will do this.

IT'S OVER.

That print likely ends the monster 3 year bear/flattener trade. I've been wrong the last 2 mths, but its been great before that.

Remained bearish through SVB, Q4'24 pivot.

We've rallied without crisis, and the easy roll up the curve is dead.

What's next?

1/ 2/ Moving back to flat rates in the US and Europe we have to consider our next move.

Being long here isn't clear, there's a lot priced for a Fed that has time to take it easy.

10s are rubbish and you have little reason to own them long-term (next newsletter on this topic)

Bonds have backed up around 20bp to LEVELS NOT SEEN since 2 weeks ago.

This is primarily a Euro story, as Bunds broke upward trend on French politics and have reversed the move just as violently.

Fed path unch, leading to steepening.

I remain very short.

1/ 2/ Year-end Fed funds have done nothing, pricing a cut in the 4th quarter.

Prime reason for continuing to stay short is that I don't think they cut, and even if they do its overpriced and they are likely to be very cautious about further messaging.

Lots of excitement to be long rates here. Weak CPI, jobs worsening (?), political Fed.

My argument against that that there isn't much upside. Remember, you have to exceed current expectations to win.

Futures still in downtrend and yet to breakout. How many cuts to break?

1/ 2/ First to explain the chart above.

This is a series calculated from chaining together returns of the US 2y futures contract and rolling at the first notice date.

Crucially it includes the roll up an inverted curve...a cost in being long.

2s10s isn't a measure of the relative performance of an actual trade in a 2y and a 10y bond (or future) when the curve isn't flat.

It doesn't suit the supply argument, but curves have been flattening aggressively all year, MOSTLY in the last 3 months.

1/

https://twitter.com/dampedspring/status/1797617274213322963

2/ The generic yield used in Bloomberg or tradingview is based off the interpolation of the curve at that point.

This gets recalc'ed every day which is the equivalent of rolling forward to a NEW 2y bond every day.

The Yen has devalued against everything, but none more convincing than against the Yuan.

Is China winning and Japan losing?

No - they are just doubling down on the same economic goals in different ways and are becoming more alike.

The battle between the Yen and the Yuan.

1/ 2/ The straight-line depreciation of the JPY against the offshore Chinese Yuan has been a better bet than the S&P from a risk-to-return standpoint.

A key narrative has been that China has been encroaching on Japan's high-value exports, and this is true.

Only 6 bullet train routes in China are profitable, and the push to raise prices to cover the maintenance, operation and debt load of these sprawling systems illustrates the issue with building infra that isn't economically additive.

NY times article linked in thread.

1/ 2/ These lines are subsidised at multiple levels - not just ticket prices but the electricity that runs them and interest cost of the debt that built them.

Electricity costs have also recently been pushed up for factories.

nytimes.com/2024/05/13/bus…